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'Hard Brexit' to 'Cliff edge Brexit' - how bad for the pound?

Publication Date: 06 Aug 2018 - By ReachX Team By ReachX T.

Environmental, Social & Governance Macro FX & Rates FX Fixed Income/Credit UK EU


Bank of England Governor Mark Carney says that the chance of a no-deal Brexit is uncomfortably high. That's a pretty dismal prospect for UK growth and an awful one for the public finances. It would be bad for the pound but from current low levels, the risk is that the UK faces years of a weak currency rather than another huge move lower, according to a leading City analyst.

In a note to clients, Kit Juckes, Head of FX at Société Générale, wrote: "A 'Hard Brexit' which we define as ending access to the single market and taking the UK out of the customs union, is our central case. We think it results in real GDP growth being about 0.5% lower per annum than would have been the case otherwise, for up to 10 years. 

"We think this will result in the pound trading about 5% lower than current levels on a trade-weighted basis in the next few years, back to the 2008 lows, but not to or through the 1976 lows in real terms. For EUR/GBP it suggests a return to levels around 0.95, but not a break of parity."

Société Générale gives a ‘Cliff edge' Brexit a 10% probability in its 2017 report, and this is what some people now mean when they talk of a Hard Brexit. Juckes noted: "This gets us back to WTO rules and maybe the chance of this happening has increased. In this scenario, I can imagine EUR/GBP getting to parity and the pound reaching a new all-time low in real trade weighted terms. But even a no-deal Brexit isn't as awful as calling in the IMF, or is it?

"I am frequently asked why the pound isn't pricing in a greater risk of ‘hard' Brexit. The unspoken assumption is that a hard Brexit would send sterling significantly lower. It would be bad, but how much it would send sterling down isn't all that clear to me."

The pound reached its all-time low in real effective terms in October 1976, after the UK had called in the IMF. It reached its highs in real terms in 1991, at the peak of the money supply targeting period, when interest rates hit 17%. 

"The 1992 fall was sharp but in real terms, but the pound didn't fall as low as it is today. The 2008 fall, when the UK suffered more than most because of the financial crisis, was more dramatic than 1992, but it seems reasonable enough that the low wasn't quite as extreme was we saw in 1976," Juckes wrote.

The post-referendum sterling fall took it to a similar level in real terms to that seen in 2009. 

In nominal terms, a new all-time low was reached in October 2016. The question all of this begs, is whether ‘Hard Brexit' would be worse than 1992, 2008 and 1976. In 1976 and 1992, the UK was coming out of recession (a mild one in 92, a deep one in 1976). 

“In 2009 the UK was in its deepest post-war recession. Today's 1.2% y/y growth rate is respectable by contrast. The balance of payments isn't in great shape, but it's improved in the last couple of years, and inflation is under control. The biggest negative about the economy in a hard Brexit isn't that it is likely to send the economy into a deep recession, but that it's likely to lock it into a lengthy period of under-performance,” Juckes concluded.


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