What does Brexit uncertainty mean for forex?

Now that we seem to be entering the end game phase both in negotiations between the UK and the EU and in the dispute between the government and the majority of MPs, what should the foreign exchange market (forex) expect?

Since the referendum on Brexit back in June 2016, the pound has been the most volatile currency of any developed country. Some traders have seen this as a fantastic opportunity but others – especially those with less experience – have found it exhausting to try and keep up with.

With no deal ruled out by Parliament (and Boris Johnson unlikely to get away with ignoring this, despite his apparent suggestion that he would be prepared to break the law to deliver on his promise), and with Guy Verhofstadt insisting that there will be no further extension from the EU unless certain conditions are met, four main possibilities present themselves.

A last-minute deal

If a deal is made at the last minute, the markets are likely to rally in response, raising the value of the pound. It’s probable, however, that this effect will be short-lived, especially as a deal made under these circumstances is more likely to be made on unfavourable terms. Far from being the end of the Brexit process, a deal would introduce a new phase of uncertainty as the UK had to renegotiate all of its import and export arrangements. Most experts agree that this would lead to a market downturn for around ten years, with some believing that it could take as long as 30 years for the pound to return to its pre-referendum value.

A general election

The defection of Philip Lee to the Liberal Democrats marked the first time that a sitting government losing its majority has precipitated a rise in the pound. With this in mind it seems likely that the announcement of an election would see the pound rally again, but what would happen afterwards? An interesting piece of news to emerge recently was that the big investment banks now see Jeremy Corbyn as a less risky proposition than a no-deal Brexit. If Johnson holds to the line that he will somehow exit the EU even if he can’t get a deal and an election is held before the date for leaving (which may be after the 31^st of October if an election extension is granted), this could mean that the pound remains unusually stable despite uncertainty as to who will win.

Another referendum

The EU has expressed a willingness to provide an extension so that another referendum can be held. At this stage, that would really have to return to something like the original question, but with public opinion turning against Brexit and population demographics shifting in favour of a remain vote, the result is likely to be just that. Because it would be seen by most people as democratic and therefore keep the number of angry objections to a minimum, this would likely be the most peaceful solution to the whole situation, with the most positive outcome for the pound.

Revoking Article 50

Although Brexit is generally considered to be bad news for the markets and therefore for the pound, simply revoking Article 50 – which may end up being the only legal option if a deal cannot be achieved – is not a simple solution. The likelihood of resultant civil unrest in some parts of the country makes it unpredictable in the short term, so although it would probably lead to long-term gains, the pound would be likely to be volatile for a few days or weeks in the aftermath of such a decision.

The pound and the dollar

One further factor that complicates this situation is the fact that the dollar is also going through a period of instability, with most experts agreeing that although it now looks fairly strong it’s likely to drop in a few months’ time as the impact of short-term gains made at the expense of the longer-term becomes clear. If you follow the charts supplied by degiro, you’ll know that the dollar has been rising against the pound despite the bumpiness of the latter overall. In most of the above scenarios, it could be expected to rise still further in the short term but drop again over the longer term.

The pound and the euro

Despite the volatility of world markets the euro has been quite strong of late. Brexit – especially a messy Brexit – would impact it as well as the pound, but less so, because of the other strong economies mitigating the damage. The smaller dip in the euro would likely result in the pound falling slowly at first against it and then dropping further after the first few days.

However you look at it, this is a volatile period and it’s likely to remain so, but it’s not without opportunities for savvy traders.