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Down the rabbit hole: Consequences of "Brexit" for GBP – Deutsche Bank

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Feb 29, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

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    Research Team at Deutsche Bank, suggests that they are taking a balance of payments approach to measure the ‘what if’ impact of a UK exit from the EU on sterling.

    Key Quotes

    The UK’s current account deficit may improve in the wake of “Brexit.” The deficit is entirely down to the EU, with large negative balances in trade in goods and primary income. In the absence of a free trade agreement after “Brexit,” the hit to UK exports would be significant, but imports would fall further, resulting in an improvement in the trade balance.

    Due to the significant hit to trade, particularly in financial services and transport equipment, a free trade agreement is likely to be negotiated. The UK may be at a disadvantage in any negotiation, as the cost to UK exports as a share of total are higher than for the EU. Under a free trade agreement, the trade balance is likely to improve less.

    The large primary income deficit with the EU is due to falling profitability on the UK’s FDI investments in the EU. This structural trend is bearish for sterling, but is unlikely to change under a “Brexit.” The secondary income deficit would improve as fiscal transfers to the EU fell, but how much would depend on the outcome of renegotiation.

    The impact of “Brexit” on capital inflows through the financial account may outweigh the improvement in the current account. The UK’s access to the Single Market is important for FDI inflows. Without a free trade agreement, FDI inflows may suffer. FDI inflows may also slow in the short term, as corporates await the result of a renegotiation. The impact on portfolio inflows is less clear cut, although a more dovish Bank of England would drag on fixed income inflows.

    The clearest transmission mechanism between “Brexit” and the financial account is the other investment balance. A UK exit from the EU could lead to a different relationship between the UK financial industry and the Single Market. If costs to cross border financial services increased, deleveraging could occur. In this case the UK would likely see net capital outflows, which have been bearish for sterling previously.

    In a ‘benign’ renegotiation outcome between the UK and EU, the impact on GBP from “Brexit” may be short lived, although initial uncertainty would lead to a frontloading of our existing bearish GBP/USD forecasts of 1.28 end ‘16 and 1.15 end ’17. In a ‘non-benign’ negotiation outcome, sterling may need a further 10% depreciation to rebalance growth.”
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