On Friday, 24th of June the UK woke up to the news that the country had voted to leave the European Union by a majority of almost four percentage points. After seemingly buying into the belief that the Remain camp would ultimately emerge victorious, currency markets, particularly the pound, quickly reversed course as the tide of votes showed that a Brexit was an inevitability.
How does the UK leave the European Union?
Despite this momentous decision, the UK is still very much part of the European Union and will be for at least the next two years. The process of leaving the EU was originally set out in law in the Lisbon Treaty of 2009 and dictates that the outgoing member must trigger Article 50 by announcing its intentions publically or to a meeting of EU member states. This then starts the statutory two-year negotiation period at the end of which, the outgoing member leaves permanently. David Cameron has already declared his intention to hand over the baton to the next UK prime minister to make the call on when and how this process will begin.
Where does sterling go next?
Despite markets finally having the certainty of the referendum result, it appears the UK public now know less than ever about the future of the UK’s economic standing and political establishment. The resignation of David Cameron on Friday and the crumbling of the Labour party has compounded the growing sense of uncertainty and that never bodes well for sovereign currencies. As such, it’s difficult to say where the pound will turn in the short-term without any clearer direction from Westminster or the Bank of England.
Many investment banks see further GBP weakness before the end of the year as the Bank of England’s tools to stimulate the economy (cutting interest rates and conducting further quantitative easing) weaken sterling further. There are few catalysts that could send sterling higher at this point, but given the unpredictability with which the referendum decision unfolded, it would be foolish to completely rule them out.
When will FX volatility tail off?
The next playmakers for UK markets could come from two distinctly different (and until recently, opposing) camps; the Bank of England and the Leave Campaign. The majority of economists and investment banks now expect the UK to drop into a technical recession in the final six months of this year and the response of the Bank of England could stoke further currency volatility in the coming months. Markets are now pricing in a 25bps rate cut from the BoE by the end of 2016 and this could come as soon as this August’s Quarterly Inflation Report, where the BoE will not only have the opportunity to take action, but also to explain and justify their decisions to the markets in depth.
The distinct lack of a roadmap for the UK’s exit from the EU has left the UK business community in the dark – the only timeline we know with certainty today is that the UK will likely have a new Prime Minister ahead of the Conservative Party annual conference in October this year – and the responsibility of triggering Article 50 will lie in their hands.
Impact on Australia
We saw a great deal of activity here in Australia following the ‘Leave’ outcome. Aussies flocked to currency exchange providers as the AUD jumped 4.5% against the pound. Here at World First, we extended our opening hours to handle high volumes of client enquiries, while CBA suspended exchanges on the pound, leaving many Aussies stranded abroad.
The Australian economy and indeed the AUD have benefited greatly from the globalised economy, namely through free trade. This economic model is now under pressure as the UK’s own right as the financial powerhouse of the world is. Basically, a continued trend towards less free trade would see a greater premium placed upon AUD assets which would hurt the AUD.
Interest Rates
The RBA will have to be even more careful moving forward. In interest rate news, there is now a grand consensus that the RBA will be cutting rates in August after the inflation data is released on the 27th of July. The justification behind this is again reflective of the global uncertainty caused by Brexit, as the RBA is now expected to provide a notional easing bias as to assure markets, businesses and households that the Australian economy will continue to grow. RBA Governor Stevens has, however, led a steady ship so far and made a point of noting that he would rather jawbone the AUD in a direction rather than delve into his rate cutting toolbox.
So what’s next?
The Aussie has managed to hold on thus far, falling a respectable 2.2% against the USD this week. The typical formula after a global economic cataclysm occurs is for central banks to start easing and investors to start buying risk assets (like the Aussie). While the Aussie has rallied post the decision as investors sought out our safe haven currency, the question remains how much higher will it go? The Australian economy has been dealt a blow, as we have remained so strong due to globalised free trade. This is all now under pressure and as a result, many major economists are still forecasting a decline in the Aussie by nearly 11% by the close of 2016. If such negative predictions actually play out, then we could see the AUD slip well below 70 cents USD.
The name of the game over the next 12 months will be volatility and uncertainty – the fallout of Brexit, US interest rate decisions and the presidential race, the performance of the Chinese economy and a likely slowdown in global economic growth will make for turbulent times.
In short, the message is that we can expect currency market volatility for a while to come and so any business or individual with a large and/or regular currency requirement should investigate ways to guard themselves in such an uncertain climate. The best course of action is to speak with us so we can understand your exposure and advise on the best products to mitigate your risk.