The Brexit elections back in 2016, sent the British pound sterling (GBP) into a spiral of chaos, in the recent years it is clear that the UK and the pound sterling have entered a new era.
The political and economic uncertainty created by the election and consequent separation of the UK from the EU generated an adverse reaction for the GBP, making price volatility and reaching a drop in the value of more than 10% already during election day. (FXCM, 2020).
Why does the Brexit affect the Pound
The pound sterling is a free-floating currency, which means that traders determine its value if people are buying money at a higher rate than they are selling it, the value increases. If they are selling the currency faster than people are buying it, then the currency’s value drops.
Recently, traders have been paying more attention to politics than economic data, which means that any political decision in a country will translate into a change of value in its currency.
Source: macrotrends.net (Euro-Dollar 2016-2020)
In the case of GBP, several things have happened since the Brexit election. After a fast drop in value accompanied the decision of splitting paths with the EU, the UK’s political uncertainty generated a rapid fluctuation in the exchange rates of the GBP. More recently, the Brexit process’s slowdown has alleviated, to some extent, the quick changes of the GBP value, because both businesses and traders have more time to plan. (Mustoe, 2019)
Since the Brexit election, the GBP has had high volatility, resembling more a developing country’s currency. This is due to different reasons, from economic expectations to pure speculation and panic.
- Expected economic weakening: As mentioned before, the traders watch political decisions and value money based on those decisions. After the UK decided to leave the EU, the standard expectation was that the UK’s economy would shrink, causing a drop in demand for its currency and, therefore, a decrease in value.
- Softer Brexit: During 2018, the GBP stabilized compared to the last year and a half, this due to the postponing of Brexit, allowing traders to plan better the future value of the currency.
- External factors: not all changes in a currency’s value come due to internal decisions, it is essential to remember that always a currency’s value is compared to any other money, so, for example, a drop in value on the dollar like the one seen at the beginning of 2018, due to America’s own internal factors, translated in an appreciation of the Pound.
Source: macrotrends.net (Pound Dollar)
- Panic: plenty of times, the value of a currency is based just in speculations, traders don’t always study a country’s economic policies genuinely to make a decision, and the choice made out of pure distrust, can unchain a domino effect having severe effects on the currency’s value.
So far this year
After seeing how the Brexit election sent the Pound Sterling on a roller coaster ride in the past couple of years, we come to 2020, a roller coaster of a year itself.
After a small recovery by the end of 2019, the Pound seemed to be stabilizing compared to past months. With the new year approaching and trade talks with the EU still ongoing, the stability was something unsure, and the exchange rates started to demonstrate it. Fast forward just three months, the coronavirus pandemic attacked the markets. At the beginning of March, the Pound Sterling had a drop in the value of 12% in a week.
Source: macrotrends.net (Pound-Dollar 2020)
After the fall of the Pound, the Uk government announced a stimulus package to encourage the recovery of the economy. After that, the GBP bounced back but was unable to reach the values from before the pandemic affected it until mid-June, when it started presenting signs of growth.
A view into the future
With the current global situation, most aspects of life seem uncertain, and the markets are no exception. According to Andy Haldane, Chief Economist of the Bank of England suggested that the Pound has shown a V shape recovery in the recent past. Still, most economists argue that the recovery process will be much slower.
A critical factor for the GBP recovery will be the Free Trade Agreement discussions with the EU. The Pound seems to respond to two specific scenarios (The closer the Uk stays to the EU, the higher the valuation of the Pound Sterling). Talks are underway to reach an agreement by year-end, but it is unlikely to see one until mid-autumn this year. Therefore, we expect to continue seeing a volatile behavior and a slow recovery, if not another drop of the Pound until then. (Doane, 2020)
After the Brexit election in 2016, the Pound has been showing a very volatile behavior, whether for internal factors such as the election itself, the implementation of new economic policies, or external factors such as the EU and US politics, and the current pandemic. The truth is that there is no one single factor to blame, and for at least a short period, things are expected to remain in a similar context.
Right now, the major influential factor for the GBP stability came back to be the future of trade with the EU, the most significant risk for it being not having reached a deal by years end, after which a slow recovery wouldn’t be by far the worst-case scenario.
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