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A Brexit would be a nightmare for the Old Lady

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Apr 6, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

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    On 20th February 2016, David Cameron announced a referendum on whether Britain should remain in the EU - seen as the biggest political decision in decades. The referendum is to be held on Thursday 23 June.

    “I do not love Brussels, I love Britain...the question is - will we be safer, stronger and better off working together in a reformed Europe or out on our own?” Cameron said in his original announcements outside of Number 10, Downing Street. “Leaving Europe would threaten our economic and national security.”

    To the FX world, our 'immediate' questions are not of the economic and national security of Britain, but the 'immediate' implications to spot and what side of the spread to be while leading up to the referendum and how to play the outcome of the vote.

    The very uncertainty of that has already seen big moves in GBP crosses and as a foretaste of what may come, the Great British Pound was dumped 2.4% just on the news that the London Mayor, Boris Johnson, was joining the Leave campaign.

    There had already been a shift in demand for GBP that started to take shape last November. Since then, the pound has fallen over 5% due to the expectations that the Bank of England will raise interest rates this year receded and while the Brexit debate started to heat up.

    Top investment bankers betting 20% devaluation of the pound

    Looking elsewhere for further insights as to what the implications might be for the price of sterling, what more a better place to turn to than the Banks? Just recently, Goldman Sachs warned that a Brexit could slash sterling by 20%. Citigroup are predicting a 15% fall out, bringing the pound close to parity to the U.S. dollar, while in a more conservative prediction, Morgan Stanley predicts a 5pc fall in sterling in the immediate aftermath of a vote for Brexit.

    GBP to remain better offered

    While there are no certainties that Britain's population will vote to leave the EU, with the polls as of 4th April, to 'Leave' 41% / 43% to 'Stay' (Source: The FT poll of polls), as we approach the 23rd June, the pound will undoubtedly remain better offered, more so against the U.S. dollar than to the euro, and then if one is looking further afield than to just the short-term FX risk, to the contrary, it can reasonably be argued that for a long time now, Britain has enjoyed far too strong a currency anyway and although a weaker pound is not all doom and gloom in respect to net trade, there is plainly some danger of what may be a mildly beneficial sell-off turning into a rout.

    Negative implications for BoE

    The implications for the BoE are tremendously negative in a worst-case scenario where they are forced to try and intervene. That might be more like spitting into the wind these days in FX, for no Central Bank is, nor are their reserves bigger than the FX market, (George Sorros in the ERM proved that to the BoE on Black Wednesday on September 16, 1992).

    The only defence the BoE might be left with would be to increase interest rates to defend the currency and prevent inflation getting out of hand. However, this would be very daring, especially while the domestic and global economy remains so fragile. Indebted households and businesses could be looking down a long and painful road ahead.

    Moreover, Britain's massive current account deficit needs to be supported by inflows of foreign capital, and therefore makes the economy particularly vulnerable to any sudden loss of international confidence.

    Recent price action GBP/USD

    GBP/USD completes round-trip and erases daily losses
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