What could Article 50 mean for Sterling?

We asked Paul Reilly of Clear Treasury for his view of the implications of Article 50 for the UK business community.

As we are all well aware at this stage, PM Theresa May and her government are on course to trigger the much discussed Article 50 of the Treaty on European Union – the formal mechanism for exiting the EU – with an expected deadline of the end of March 2017.

One question that we are continually asked in Clear Treasury is whether this will have further impact on the value of sterling?

Whilst we ideally would like to be able to answer this question with a higher degree of confidence, the one thing financial markets and other so called ‘experts’ have learnt is that political risk is something very difficult to model and predict. From a FX perspective, this uncertainty can have a major impact on the value of a currency. As we have all seen at this stage, from a sterling perspective, this resulted in a significant fall in the value of the pound ever since June’s referendum result. Against the US Dollar it fell a 21% high to low and versus the single currency, 16%

Going back to the question as to the potential impact on sterling, the simple answer is yes – the triggering of Article 50 will have further impact but how much? Any additional political uncertainty will create further periods of volatility and weakness for the pound with rates of 1.08/1.09 against the euro a distinct possibility again. However, unlike the path sterling travelled from June to its October low, it is unlikely that movement in sterling will be as one way traffic as it was then for a number of reasons:

  1. Movements in sterling in recent months have shown an appreciating currency and versus the euro, is very close to the 50% retracement mark of its June 23rd high to its October low. This suggests markets are more comfortably holding sterling than previous.
  2. European political risk – There a number of political events elsewhere in Europe and none more important than the French and German elections. France currently carries the most political risk as National Front candidate, Marie Le Pen, whilst still an outside risk to win, according to polls still holds enough support to warrant attention. Apart from her other policies, one thing Le Pen is noted for is her anti euro attitude and threats to pull France out of the currency union should she get elected. This would have disastrous consequences for the euro project.
  3. Inflation and MPC – In a normal environment, central bank monetary policy is typically the main driver of a currency’s value. As highlighted, political risk now has a more influential role over financial markets in recent times. However, the Bank of England may take more of a key role as UK inflation continues to rise. Forecasts are projecting inflation to be back above the 2% target by early summer and 3% by year end. Price rises at 2% plus will put the Bank of England under pressure to act and potentially in the form of interest rate rises.
  4. Softer Brexit, parliament involvement – As per the recent Supreme Court ruling, the formal triggering of Article 50 must now require votes in both the House of Commons and the House of Lords. As two thirds of the member of the House of Commons initially supported the ‘Remain’ campaign, the court ruling is expected to create a softening of Theresa May’s approach to negotiations with the EU. The line between a perceived ‘Hard V Soft’ approach towards Brexit negotiations has typically been a line to either Sell or Buy sterling.

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