UK: No relief in sight for the pound - MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the pound has continued to decline sharply in the Asian trading session as market participants are still digesting the potential fall-out from the British public’s decision for the UK to leave the EU.

Key Quotes

“While the decision to leave was a big surprise for the market even as the polls were relatively close beforehand, the initial market reaction is broadly in line with our expectations with the pound hit hardest.

Other European currencies are underperforming alongside the pound as investors are fearful over the negative shock for the economy and political stability in the rest of Europe as well. It has triggered an intense flight to quality bid boosting demand for the yen, Swiss franc, and US dollar and capital outflows from high beta assets weighing heavily on emerging market and commodity related currencies.

Global leaders and major central banks have attempted to provide reassurance in an attempt to dampen market volatility. The current negative external environment is likely to persist for the foreseeable future keeping pressure on the Japanese and Swiss authorities to act to dampen domestic currency strength although policy action will struggle to gain much traction. The SNB have already confirmed that they have intervened.

The British public have made a big gamble which leaves the pound and the UK economy very exposed in the near-term. The UK’s already elevated current account and fiscal deficits, and size of the UK’s financial sector which are amongst the highest in the world clearly highlight the vulnerability of the pound and UK economy.

Moody’s and S&P have already warned that the UK’s credit rating is likely to be downgraded.

The sharp plunge in the pound is likely to result in a temporary period of higher inflation which will squeeze real disposable incomes while wage growth remains weak further undermining the outlook for consumer spending which has been the main driver of growth in the UK. The weaker pound will at first increase the value of imports widening the trade deficit but should help to offer more support for growth in the years ahead if the pound remains at more competitive levels.  However, weak global growth will act as an offsetting dampener for export growth. On balance the UK economy is likely to stagnate at best in the year ahead with a heightened risk of falling into recession.

The current period of heightened uncertainty appears likely to prove prolonged. Prime Minister Cameron has resigned and a new Conservative Party leader will not be in place until October.  After which the new Prime Minister may want to call an early general election.

Adding to the uncertainty will be the high likelihood of another Scottish independence referendum after Scotland voted overwhelmingly in favour of remaining within the EU.”