Pound bruised as Brexit deal doubts creep in
LONDON, Oct 14 (Reuters) – Sterling gave up some of last week’s strong gains on Monday after the European Union and Britain said a lot more work would be needed to secure an agreement on the country’s departure from the bloc by Oct. 31.
The pound fell more than 1% to a session low of $1.2517 . Against the euro, the British currency weakened by a similar margin to 88.11 pence.
“Don’t take a Brexit deal for granted and the bigger risk here is what concessions will be made from either side,” said Neil Mellor, a senior currency strategist at BNY Mellon.
Though the mood music for the pound’s short-term outlook has improved considerably over the past week, market watchers, including UBS, warned that there were still hurdles in the way of Britain and the EU agreeing a deal.
What compromises each may be prepared to make will be key, with too many concessions by the EU potentially compromising the integrity of the single market and the British side hampered by internal political obstacles, UBS said.
Reflecting the uncertainty, gauges of volatility for short-term sterling instruments soared with one-week maturities trading above 16 vol, more than double last week’s reading and close to its highest level this year.
The rise in expected volatility has inverted the term structure for expected price swings in the pound to its most extreme levels this year, with shorter-dated volatility rising more than volatility gauges in longer-maturities as traders brace for more short-term Brexit news.
The latest positioning data showed a further unwinding of extreme short positions though they still remain large by historical averages, indicating that any news of a Brexit deal could squeeze the pound sharply higher.
Depreciation refers to when a currency loses value when compared to another currency, and likewise appreciation refers to when the opposite is true, and a currency is worth more than the currency that it is being compared to.
Consumer confidence is a statistical measure of consumers’ feelings about current and future economic conditions, used as an indicator of the overall state of the economy.
A trade agreement is an agreement between two or more different countries that aims to lower administrative barriers and increase imports and exports between these nation.
The article above mentions that as a result of the uncertainty behind the new Brexit deal the Great British Pound (GBP) has depreciated in value as a result of lower consumer confidence. As can be shown in diagram 1, the initial demand of the GBP is at equilibrium with supply, however as the consumer confidence decreases (as a result of uncertainty of the effect of Brexit) the demand shifts to the left, intersecting the supply curve at a lower point resulting in a lower value of the GBP and a lower amount on the foreign exchange market (FOREX).
There are several main factors that can be attributed to this volatile time for the GBP. Brexit would essentially result in the UK leaving the several EU trade agreements that were set up, and this major cancelation could potentially have huge impacts on all the major economies that rely on trading and investing in the UK and vice versa. This uncertainty of what the UKs actions will be, and their results, make interactions with the UK less favorable and as a result the demand of exports from the UK might drop, for example, if many EU nations (such as Germany, France and Italy) have now less favorable trade agreements after the UK leaves the EU then their demand for the currency might drop as there will be less exports. Another major factor that may be affecting the depreciation of the GBP is that with all this uncertainty in the future the UK could be experiencing a fall in foreign investment, and with such a fall less of the GDP is demanded to be reinvested into the country.
The two major consequences of this current depreciation are the changes in exports and imports in the UK. As the GBP lose its value (for example losing 1% of its value and equaling 1.25 USD) its exports become less expensive to other nations because other currencies can get more GBP for the same number of their currency. On the other hand, as a result of this drop in value the imports become more expensive because the purchasing power of the GBP has fallen. Further consequences include hurting consumers due to these higher costs and firms that are dependent on imports are strongly affected due to a fall in imports.
To conclude with this evaluation, the UK is facing one of the most important decisions in the 21st century as a country, and they need to make a decision quickly (regardless of the what the decision is) so that it can improve the consumer confidence and decrease the uncertainty within and outside of its borders.