The British pound has struggled against other major currencies in recent weeks, in part a consequence of a growing lack of confidence that the United Kingdom will leave the European Union with a deal. The transition phase of the UK’s departure from the EU concludes at the end of 2020, with no extension to the deadline expected. By the start of 2021, markets will have a definitive idea of what a post-Brexit British economy will look like.
While the shape of that economy will hinge on whether the UK leaves with or without a deal, at the very least there will be a degree of clarity that has been lacking throughout the protracted Brexit process. Markets never respond well to uncertainty, and foreign exchange markets are no different. Brexit has been the defining influence on the value of the British pound (GBP) in recent years, and it continues to affect the currency’s performance against the US dollar (USD) and the euro (EUR).
Brexit uncertainty breeds currency volatility
At times when a no-deal Brexit has looked like a serious possibility, traders have lost faith in the long-term upside of the GBP. On occasions when it has looked like the UK will leave the EU in an orderly fashion, the pound has made gains. That was the case when the Conservative Party secured a majority in the 2019 election, as it was believed the Tories would have a mandate to push through a Brexit deal. The rise in GBP following the Conservative win wasn’t necessarily an endorsement of Brexit, given that markets are dispassionate, but the realistic hope of a smooth end to the process gave traders the confidence to invest in the pound once again.
This happened again in mid-August of 2020, when sterling drove towards a five-month peak against the dollar after Irish Prime Minister Micheál Martin stated his optimism that the UK and EU would find common ground on a trade deal. A month later, market sentiment had swung in the opposite direction. On September 9, the pound sunk to six-week lows against both the dollar and the euro following reports of the UK government’s willingness to renege on its existing withdrawal agreement with the EU.
That created new fears that the UK would depart from the EU without a deal, which has made September a month of decline for the GBP. One of the most effective ways to track the changing value of the pound is to analyse the currency pairs featured by the top online forex brokers, with the GBP/USD currency pair one of the most heavily traded markets. In a currency pair, traders buy one currency in order to sell another. In the case of the GBP/USD pair, its value indicates how many dollars would be required to purchase one pound. Brexit uncertainties generally encourage widespread selling of the pound, which drives down the value of sterling.
At the start of September, the pound was trading around the $1.34 mark. By September 23, the pound had slipped by approximately 5% to $1.27. While the UK government’s suggestion that they would circumvent the existing withdrawal agreement isn’t the only factor to affect the value of the pound, it is clear that Brexit continues to be one of the dominant influences on the British currency. On September 8, FX Strategist Jordan Rochester rated a no-deal exit as a 40% possibility with scope for that percentage to rise. That level of uncertainty isn’t encouraging for investors, who may decide to stay away from the pound as a result.
If a deal looks like the most likely outcome for the UK’s departure, the pound should recover in the latter months of 2020 and regain ground against what is a weaker-than-usual US dollar. If the government doubles down on a no-deal exit, the pound may plunge further. Once 2021 begins there will be clarity on the UK’s status either way, which will provide a clearer outlook on the British pound’s prospects for long-term growth.