Will Brexit Pound Britain’s Currency Below Parity with US Dollar?

Posted on Posted in Currencies & Forex

GBP-USD-British-Pound-Dollar1The uncertainty of if Britain will decide to exit the EU is passé as the decision to leave has been made. The unanswered part of this economic calculus is “when”, which remains a variable. What we do know is that Britain will have to renegotiate terms for a new economic relationship with the EU and that it is not willing to invoke Article 50  (Lisbon treaty which allows it to exit) before the end of 2016. Of course, investors would at least prefer some clarity on any developments leading up to these negotiations, but with Britain’s new prime minister, Theresa May, just settling into power, this too is not the case.

For now, the best insight we can glean comes from the UK’s BOE.  In a recent interview with the Financial Times, Monetary Policy Committee member, Martin Weale, stated his support for immediate monetary stimulus based upon Brexit impacting the UK economy more than expected. The markets are expecting the BOE to reduce rates from 0.50% to 0.25% as a result.

This leads me to ponder another variable, which is the forex market’s outlook for the British Pound (GBP/USD). As Brexit will have a long-term impact on the British economy, it is only appropriate that one views it currency from a long-term perspective as well. A 20+ year monthly chart should provide sufficient perspective. The one below shows a key support violation at the neckline of a head and shoulders pattern, which has its own bearish implications. Thus far, the pound has already retraced more than 100% of its previous cyclical advance. If you believe in the chicken bones of technical analysis, then the next Fibonacci target is at the 161.8% level or 0.91, which translates into sub-parity with the US Dollar.

 

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This above scenario would take time to develop and from a trade balance perspective, it would even make the UK quite competitive, which is not necessarily a bad thing for Britain. Such a move would occur over the course of months (if not a couple of years), but if the Federal Reserve Bank is committed to raising interest rates, doing so will send the pound lower and on a path with very little price support along the way.

 

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