This is the fifth article in our blog series on what businesses need to know about key global currencies in the second half of 2018. Sign up for our weekly FX newsletter to get these articles sent straight to your inbox.
Read on as we look at various challenges the pound sterling faces including onerous Brexit negotiations, interest rates, and a U.S.-U.K. trade deal. Here's what businesses can expect from British pound sterling in the upcoming months.
Since its April high of 1.43 this year, the GBP/USD exchange rate has fallen almost 10% to a range between 1.30-1.34 as we enter the second half of the year. Brexit continues to be the dominant factor for Sterling, as the British government continues to struggle for a workable way forward.
Brexit has led to deep
divisions within the ruling
Conservative party between
"Brexiteers" and "Remainers"
As predicted by many political observers, Brexit has led to deep divisions within the ruling Conservative party, between "Brexiteers" and "Remainers". While Prime Minister Theresa May often repeated her mantra that "Brexit means Brexit," her government changed its approach in July 2018, culminating in the publication of its Brexit white paper, which advocates a softer Brexit. This would see the U.K. maintain certain regulatory and customs conditions with the E.U. This decision led to the resignation of the former Brexit Secretary David Davis and former Foreign Secretary Boris Johnson, two of the government's former leading Brexiteers. The resignations weakened the pound against the U.S. dollar, and any further cabinet resignations could result in GBP declines.
The corporate sector and currency markets reacted positively to the announcement of the change in approach from the government, raising the prospects of a soft Brexit, which would allow the U.K. to maintain access to the European single market and customs union. However, the uncertainty caused by Davis' and Johnson's resignations, and the likely further resistance and resignations from within her own party may weigh on the pound until Brexit's looming deadline in March, 2019.
The E.U. and U.K. are in
opposing positions when
it comes to making a deal.
Challenge 1: European Union's Chief Brexit Negotiator, Michel Barnier, has said that the UK's Brexit White Paper proposal represents a risk to the future of the E.U. Right now the two parties - the E.U. and the U.K. - are in opposing position when it comes to making a deal. May's government must somehow find a way forward that respects the Brexit referendum vote while negotiating a deal with the E.U. that protects the U.K. economy, and which the E.U. agrees to.
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Challenge 2: May's other massive headache is that even if her government manages the formidable task of negotiating a deal with the E.U., it will be difficult for her to then convince the Brexiteer factions within her party to vote for it in parliament. If parliament does not approve, leaving the E.U. without a deal would be more likely. This worst-case scenario would see the U.K. revert to unfavorable World Trading Organization (WTO) trading rules on March 29, 2019, like higher import and export tariffs. This result would also likely lead to higher food prices across the U.K. It is predicted that WTO rules would see U.K.-E.U. trade reduce by 40% over a ten-year period.
"Rates can be expected to rise gradually.
Policy needs to walk, not run."
The Bank of England recently raised interest rates by 0.25% for a 0.75% base rate - the highest rate for nine years. Speaking about this policy, Bank of England Governor Mark Carney said, "Rates can be expected to rise gradually. Policy needs to walk, not run". Financial markets foresee one or two more rate rises of 0.25% by 2020. Rather than boost Sterling though, Carney's cautious tone actually led to GBP declines.
Investment and a U.S. Trade Deal
One bright spot for GBP is that economic performance has seen the country rebound from a slow first quarter of the year. Economic forecasters expect the U.K. to further pick up pace, predicting second quarter U.K. growth of 0.4%, rising to 0.5% in the third quarter, thanks to a strong services sector in particular.
After initially suggesting that a soft Brexit deal would "kill" any chance of a trade deal between the U.K. and U.S., President Trump subsequently changed his position. In comments made on his visit to the U.K., Trump opened the door to a post-Brexit bilateral agreement, helping to encourage some confidence in GBP moving forward. However, given the U.S. president's contradictory statements and the general air of uncertainty regarding Brexit, investors are proceeding with caution.
What businesses need to know
Global businesses exposed to GBP need to prepare for two likely outcomes:
Soft Brexit Outcome: This could see the U.K. maintain trade and customs links with the European Union. This is the outcome much favored by businesses, as well as investors, and would likely strengthen GBP considerably. For companies dealing in FX that buy GBP, such an eventuality would make exchanges more expensive.
No-Deal Brexit Outcome: A failure to reach agreement by the March 29, 2019 deadline could lead to a major selloff in GBP. This would make GBP cheaper to buy and more expensive to sell.
Companies should measure their GBP exposure and develop a risk management strategy to follow based on these two outcomes. By keeping a close eye on market events regarding Brexit proceedings as well as staying current with U.K. economic issues that will affect GBP, companies can then revise and update their strategy in line with business objectives.
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