How Brexit is Impacting the British Pound Sterling and the Euro

In 2016, a Brexit Referendum was conducted in the United Kingdom to decide whether it would remain part of the EU or leave. The surprise outcome, which was 51.9 percent for ‘leaving’ and 48.1 percent for ‘remaining’, sent the valuation of the British Pound Sterling (GBP) into complete chaos. The aftermath of this Brexit vote showed that the public wanted the UK to withdraw from the European Union and it marked a new era for UK as well as GPB. A large part of the financial community had believed that an outcome in favor of Brexit was highly improbable.

However, England turned out to be the deciding factor in the UK exist from the European Union, fueled by concerns over immigration, fair trade and national security. As England boasted the largest portion of the United Kingdom’s electorate, its edge of 1.9 million votes was the primary reason the ‘leave’ option won. Surrounded by economic and political uncertainty, the currency markets facing the British Pound Sterling negatively reacted to the idea of a completely autonomous UK. The pricing volatility for the Pound sterling reached dangerous levels and there was a more than 10 percent decline in value only hours after the vote was final.

This fallout in the currency market marked the beginning of a volatile and tumultuous period for the British Pound sterling. Throughout the process of the UK exiting the EU formally, unique challenges seem to have surfaced. From a pending Scottish Independence Referendum to the enactment of Article 50 of the Lisbon Treaty, the transition after Brexit has brought the status of GPB in the future into question. Article 50 of the Lisbon Treaty is a part of the European Union law, which lists the process to be followed when a member state is formally exiting the union and comprises of five specific provisions.

The triggering of Article 50 was halted by a legal challenge in November, 2016 and it cited that a Parliamentary vote had to be conducted first. For a time, this challenge was upheld and this allowed the British Pound Sterling to gain 1.2 percent in value against the United States Dollar (USD). The optimism of the market about the United Kingdom potentially staying in the European Union lasted for a number of months until spring 2017. The Parliament voted in March, 2017 to pass the Article 50 bill, which effectively cleared the hurdles for invocating it.

When the decision of the Parliament reached the news wires, there was a decline in the value of the British Pound Sterling against the US, which was approximately 0.7 percent. The fall in value of the GBP was a result of renewed skepticism about the future of UK’s economic prowess as well as the procedural uncertainty over the transition process of Brexit.

On 29th March, 2017, Prime Minister Theresa May officially invoked Article 50. When the European Council received a signed letter by May, it marked the commencement of the two-year period for transition negotiations. In the immediate aftermath of the invocation of Article 50, there was a 0.3 percent decline in the value of British Pound Sterling against the USD. This extended the losses post-Brexit Referendum as they reached 17.5 percent.

Reaching a deal between the European Union and the UK regarding the actual conditions of withdrawing is a multifaceted endeavor. Some of the items that are crucial in the discussion include the preservation of existing trading relationships, ongoing financial obligations and the Ireland border. Officially, the transition dealings were launched in November 2017 with the negotiations of the ‘divorce bill’ between the EU and the UK. A cash settlement was outlined in the divorce bill, which was to be paid by the UK as a compensation for its share of existing spending commitments of the Union.

Payments are upwards of £80 billion, which is 13 percent of the total European Union budget, and are to be made over time. While the payment might be regarded as unreasonable by some, economists have argued that UK will save money in the long run with the divorce bill. If the UK opts for a ‘Hard Brexit’ i.e. without a transition deal, it will cost the economy around £190 billion by 2030. After the announcement of the divorce bill, the British Pound sterling rallied once again against the USD as it climbed 0.6 percent and reached two month highs.

A common theme was illustrated by the price action throughout the process of Brexit; elimination of any uncertainty serves as a catalyst for rise in the pound sterling. On March 19th, 2018, a deal was announced by the officials governing the two-year implementation period after UK’s scheduled exist from the European Union. The deal was led by chief negotiators David Davis and Michel Barnier and put to rest a number of questions surrounding the end of the Brexit process.

The implementation phase or transition period is set to start on March 29, 2019 and will last until December 31st, 2020. The purpose of this 21-month period is to provide adequate time to affected governmental agencies and industries to make the preparations necessary for a smooth transition. Once it is completed, permanent guidelines for UK/EU relations in the future will be put into place. There are several key elements in the implementation agreement that are designed to promote a seamless transition for Britain’s exit.

The transition deal marks a significant step in preserving the long-term relations between UK and EU. There are points of contention such as the Northern Ireland border and fishing rights, most of the economic concerns associated with Brexit transition are thoroughly addressed. When news of the agreement went public, the British Pound Sterling not only rallied against the USD, but also against the euro (EUR). Following the announcement, the trading session showed that GBP had gained 0.9 percent against USD and 0.7 percent against euro. Long-term projections for the British Pound sterling were raised by numerous institutional investors, citing higher chances of a tightening monetary policy by the Bank of England (BoE).

As a result, bullish sentiment crept into the marketplace towards the British pound sterling. A number of leading proponents of Brexit resigned their positions on the transition team abruptly, amidst tense negotiations. Starting from 8th July, 2018, in a 24-hour period, UK Foreign Minister Boris Johnson and Brexit Secretary David Davis each took their leave from the process. Furthermore, one of the deputy ministers of Davis, Steve Baker also gave in his resignation. Due to these sudden departures, the uncertainty facing the GBP as well as the UK leaving the European Union also grew.

One of the major reasons for this departure was a disagreement with Theresa May, the UK Prime Minister, over the extent of concessions that were to be made in the ongoing negotiations. Davis and Johnson cited the terms mentioned in the Chequers memo as ‘too soft’ in regard to preserving the interests of the UK, thus choosing to tender their resignations. A number of items that are outlined in the Chequers memo are cited for undermining Davis and Johnson’s desire to do a hard Brexit. The Chequers memo was referred to as a ‘semi-Brexit’ by Johnson in his resignation letter and he said that it put the United Kingdom on the way to ‘colony status’.

The fluidity of the Brexit process as well as the political stability of the UK leadership was undermined due to these sudden resignations. Consequently, there were increased chances of Prime Minister Theresa May getting a Conservative Party vote of ‘no confidence’. Ahead of the UK departure date in March 2019, the idea of a potential snap election for the position of Prime Minister also gained considerable steam. There was a substantial impact on the British Pound sterling of each resignation. As far as David Davis is concerned, the volatility experienced by the GBP was moderately positive.

In the few hours after he officially stepped down, the British pound rallied 0.6 percent against the USD and 0.3 percent against the Euro. However, the optimism towards British Pound sterling turned out to be fleeting as Boris Johnson’s resignation flooded the news a couple of hours later. The gains that had been made by the GBP after Davis’s resignation were given back promptly as the GBP fell 0.3 percent against the Euro as well as USD. The forex session was ended by the pound on a down note due to the timing of Johnson’s resignation.

In a nutshell, the departure of both Johnson and Davis indicated upheaval on the UK end of the Brexit transition process. The chances of a formal challenge to the leadership of Theresa May were on the rise and this caused the GBP to experience increased volatility because of the perception of political risk by the market. As a matter of fact, numerous currency analysts predicted a massive depreciation in the value of British Pound sterling in the event that a leadership turnover is to take place. Despite the shakeup in the leadership of the transition team, the Brexit process continued to move forward, but the stability of GBP was plagued by the ambiguity concerned terms negotiated previously.

As a general rule, markets don’t see uncertainty as favorable. The 2016 vote in Brexit’s favor brought about high levels of investor angst concerning the British Pound Sterling, which could only be compared to the aftermath of Black Wednesday or World War II. Subsequently, the transition process has become a rollercoaster ride for the valuation of the GBP. While the events discussed above certainly influenced the price of the British Pound sterling across the forex, some impact was also due to the unexpected resignation of leadership.

Uncertainty was intensified due to the departures of Johnson and Davis regarding the prospect of a soft or hard exit. Therefore, significant short-term volatility was seen in the value of GBP as the UK had to deal with turnover in the Brexit transition team. The initial shock after the vote had undoubtedly been extreme. The future of the UK was thrown into chaos and this caused the British Pound Sterling values to plummet. With time, the details surrounding the withdrawal of the UK were hammered out and this eliminated a number of concerns. In the 18 months after the vote of Brexit, the British Pound sterling had made a 50 percent recovery as the GB/USD reached 1.4000.

But, as far as performance against the Euro is concerned, the values remain depressed as they hovered near the ones post-Brexit. The issue of Brexit has been a source of considerable uncertainty and drama in Europe as well and many of the risks it brings are still unknown as negotiations are ongoing. Since the vote, the Euro has gained significantly against the British Sterling Pound, but this has mostly been because the GBP has dropped against almost everything due to Brexit and not because the Euro is stronger.

This has been ascertained through the comparison of Euro with USD. The pattern has shown that the buying power of the Euro, whether against USD or GBP, is more affected by the falls and rises of these currencies in global markets instead of events that trigger them. A weak pound could cause problems for both sides of the equation as purchasing things from Europe will become expensive for Britain whereas the latter will want to import less from Eurozone countries. This could have a negative impact on businesses that trade with Britain in the long term.

The future of the UK is still a subject of debate. Britain’s ability of crafting its own trade deals during a global economic resurgence is regularly cited as a potential cause of prosperity. In contrast, Scottish independence and uncertainty about the fishing industry could hinder economic performance. Ultimately, until negotiations continue, time will tell if the economic growth and BoE’s policy in the UK will drive the British Pound Sterling higher or not. Despite rallies, it is still expected to remain low against the Euro for the foreseeable future, depending on Brexit transition terms.

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