Brexit: The Pound Will Survive, The Euro Will Not
Friday, June 24th will be remembered as a Black Day for the British Pound. On that day, investors, shocked by the “leave” vote for Brexit, pushed the Pound off a cliff, toward its worst daily loss since 1985. And yet, despite the Pound being at the eye of the storm after the Brexit vote, it’s not the Pound’s future that investors should fear.
Brexit Impact On The Pound Sterling
The impact Brexit will have on the Pound should be divided into two ranges—short to mid-term and long-term.
In the short to mid-term, it’s undeniable that the Pound will face significant and broad pressures—monetarily, fiscally and economically. The Bank of England will likely need to deploy extra liquidity measures to assure stability in the financial system which, effectively, is monetary easing. From a political standpoint, uncertainty has increased dramatically. On Friday, the UK Prime Minister, David Cameron, resigned, and his “heir apparent” is still unclear. But even more, troubling is the future of Scotland within the United Kingdom. The Scots will be compelled to cast another vote, this time on their willingness to leave the United Kingdom and stay with the European Union.
Of course, from an economic standpoint, uncertainty will transform into lowered confidence. The UK real estate market, which is dominated by foreign investors, will be under pressure. Moreover, consumer spending is likely to drop quickly. Adding it all up, it’s undoubtedly negative for the Pound and will weigh on the currency for a while.
Over the long term, however, the picture seems much brighter. Once the shockwaves fade, the tide for the Pound should turn favorable. As the EU is likely to continue to remain unstable, the Pound Sterling will become less and less exposed to the EU. In time, it could, in fact, turn into a safe haven currency. Inflation is likely to be higher and will warrant a tighter monetary policy from the Bank of England. As far as trade goes, the business community is likely to push hard for “business as usual,” which will allow the UK to keep trading with the EU in large volumes. The difference is that now, UK businesses will have no EU “red tape” hurdling them. All of that will allow the Pound to eventually recover, although that recovery might come slowly and only after plenty of choppiness.
Euro’s Future At Risk
Although the Euro took a much shallower plunge than the Pound initially, over the long run the Euro has likely already received its “knockout blow.” The departure of the United Kingdom from the European Union is a clear signal that the Euro is reversible. Although there is a distinction between European Union members and Eurozone members that are all denominated in Euros, it’s hard to see one surviving without the other. If the European Union could unwind, so can the Eurozone, and if the Eurozone can unwind then the Euro can unwind, too. Risk premiums across European bond markets and money markets will have to move higher and higher, and integration across the EU will weaken. Stake it up with a rigid regulatory environment and weak economic performance and the incentive for other EU members to leave will grow with time, and there is nothing that the European Central Bank can do to stop that. It might not happen today or tomorrow or even this year, but every crisis will incentivize one member or another to contemplate leaving. And under such circumstances, it is hard to see how the Euro’s long term path will be anything but south.
Note: The author of this article is Lior Alkalay.
Category: Commodity Trading
