CHART OF THE WEEK
On the heels of last week’s agreement between the British government and its EU partners, David Cameron announced that the referendum on the UK’s continued membership in the European Union would be held on 23 June. The issue has created rifts within Britain’s two biggest parties. In the Conservative ranks, several government ministers and Boris Johnson, London’s ever-popular mayor, have declared they will be campaigning for “out”.
Our analysis
The pound sterling immediately slid 1.8% against the dollar and shed 3.7% over the week. It also lost 2.6% of its value against a basket of currencies representing Britain’s primary trading partners – its sharpest decline since 2009. This shows that investors use the exchange rate to insure themselves against “Brexit” risk.
Bond yields are unlikely to go haywire, as Britain has its own central bank. At the same time, a weaker currency is good news for equities. Following the pound’s forced withdrawal from the European Exchange Rate Mechanism in 1992, the Footsie shot up 20.5% between 16 September and 31 December, while the CAC marked time, the Dax fell 2.5% and the S&P 500 added 3.8%.
The United Kingdom is running a high current account deficit (4.7% in 2015 according to the IMF) that has to be financed – whereas leaving the EU could make it harder for the country to attract the capital flows it needs to pay the bill. So the pressure on sterling seems set to continue.
The opinion expressed above is dated as of February 26th, 2016 and is liable to change.
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