A brief take on the US dollar and the UK pound following Brexit


Michalis Florentiades, XM Investment Research Desk

Brexit was one of the year’s key events, which caused quite a lot of volatility initially.  Looking at the currency market, it is worth revisiting some of the key recent fundamental influences for two currencies in particular; the pound and the US dollar.

Starting with the pound, it is interesting to note that the initial shock devaluation that Brexit inspired was followed by some sideways action.  Bank of England stimulus hurt the pound initially, but stronger-than-expected economic data created some stability and prevented the pound from falling more.  The quick appointment of Theresa May as Prime Minister also helped the pound.  Concerning the future of Brexit itself, few concrete policy details have emerged and it looks like the market wants to get some hints before deciding whether to push the currency up or further down.

It is therefore a little bit strange that a rally in pound / dollar to a near 2-month high around 1.3445 on September 7, has quickly collapsed to drive the pound below 1.30 today in the absence of any bearish economic numbers or hints from the Bank of England that further stimulus is on the cards.  Although it is difficult to explain the market’s action, it does appear that some political statements concerning how Brexit negotiations will proceed, are presenting challenges and creating uncertainty.  Before negotiations begin – probably during the first half of 2017, the positions of the UK and the EU appear impossible to reconcile and the uncertainty over the final outcome could reduce foreign business investment into the UK.

Therefore statements over immigration, the timing of the triggering of Article 50 etc. out of the UK, combined with statements out of the EU about the loss of UK financial companies’ ‘passporting’ rights and general access to the single market, might have caused an otherwise complacent market to ‘wake up’ to some of the economic and political risks.

What will be very interesting is whether the drop in the pound is going to challenge the post-Brexit lows.  In particular, euro / pound traded as high 0.8724 and pound / dollar traded as low as 1.2865 in the aftermath of Brexit.  At the time of writing the two pairs were trading around 1 pence and 1 cent away from those extremes.  Although the risk is for more sterling downside, it will probably take a bit more than jawboning from the two sides to drive sterling substantially lower.  Whatever the outcome, the test of the high in euro / pound and the low in pound / dollar will certainly be a key focus point for pound traders over the next few days.

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Turning attention to the US dollar, Brexit has definitely helped the dollar as the world’s reserve currency and far removed from the woes of the UK and the Eurozone as they struggle to define their future economic relationship.  The dollar index peaked at nearly 97.5 almost a month after Brexit, helped by strong US economic data.  Indecision by the Federal Reserve in late July concerning a rate hike and subsequent data on the weak side led to some US dollar selling until the second half of August, when relatively hawkish statements by Fed officials rekindled the prospect of a rate hike in September.  Those hopes fizzled out and the market is now more focused on December as the most likely candidate for a rate hike rather than September or indeed November.  The US elections in November could also create some uncertainty so the elections together with a cautious Fed, could restrain the dollar’s upside.  At the same time, the prospect of higher rates in the United States at some point makes the dollar slightly more attractive compared to other currencies such as the yen, the euro and sterling.  The central banks in the UK, the Eurozone and Japan are all currently engaged in aggressive quantitative easing campaigns, while the ECB and the Bank of Japan are experimenting with negative rates.

To sum up, a key test lies ahead for the pound while the US dollar’s relative stability is set to continue provided that the US economy also stays on a firm footing before and after the US elections.