A Disaster In Waiting For British Pound Sterling Read

Rifan Financindo Berjangka – Everyone I?ve read agrees -?if Britain votes to leave the EU, the British pound will get pounded. Markets don?t like uncertainty, and Brexit would be the apotheosis of uncertainty:? two years (at least) of heated negotiations while Britain and the EU worked out the details of a messy divorce.

Simultaneously, Britain would have to work out trade agreements with all the other countries that it currently trades with under the aegis of the EU. How long would that take? The EU and Canada have been negotiating their trade agreement for seven years now. Multiply that times most other countries in the world, and…you get the idea.

German Finance Minister Wolfgang Schauble said there would be ?years of the most difficult negotiations,? which would be ?a poison to the economy in the UK, the European continent and for the global economy as well.”

Meanwhile, of course, what would the Scots decide? It?s unclear whether they would be willing to leave the EU in order to remain linked with the rest of the UK. Brexit could mean Scexit as well.

But for sterling, it?s worse than that. It?s not just the short-term uncertainty. The longer-term impact on the country?s balance of payments would be disastrous. That?s why I think even though sterling has fallen a lot ahead of the referendum, if they do vote to leave, it will be even worse.

The problem, in the first instance, is the UK current account.

As you can see, the country has a huge trade deficit, which is somewhat offset by the surplus in services. The biggest net surplus is in financial services. But if the UK decides to leave the EU, will it still be able to maintain the surplus in services? Paris and Frankfurt are itching to shift the center of finance in the euro into the Eurozone. Without being able to ?passport? their businesses throughout the Eurozone, Britain could well lose much of its comparative advantage in financial services. That would shrink the service surplus and drive the current account deficit ? already a record as a percent of GDP ? even wider.

In any event, the country needs that surplus to offset the growing deficit in primary income ? income from bonds and dividends. Britain has the fourth largest stock of foreign direct investment in the world. These companies are paying dividends to their overseas headquarters.

Until 2012 that was offset by income from Britain?s own substantial overseas assets. But Britain?s foreign investments are in industries that haven?t been doing so well recently, such as mining, finance and telecoms. That surplus has changed into a deficit that, on current trajectory, could push the current account deeper into deficit over time on its own accord.

This problem didn?t matter too much to the FX market when overseas investors were piling into British assets. But will they continue to do so after the UK votes to leave the EU?

Looking at the basic balance, you can see that most of the inflow offsetting the current account deficit is portfolio investment, that is, purchases of stocks and bonds. That?s likely to suffer on both accounts if the ?leave? side wins. On the one hand, the UK stock market probably won?t like the uncertainty any more than the FX market will, and it may be hard to get foreigners to buy into companies based in Britain.

On the other hand, if Britain leaves the EU, the Bank of England will almost certainly have to keep interest rates low for longer than it would otherwise, and might even have to resurrect its monthly bond purchases. That would reduce the yield on gilts and make them less attractive to foreign buyers.

The net inflow of direct investment is also a substantial offset to the current account deficit, and that seems sure to suffer as well. A survey last year of some 400 companies by consultancy Ernst & Young found that 72% said access to the single market was important to the UK?s attractiveness and 31% would freeze or reduce investment until the outcome of the vote is known. In that case, we can guess that a vote to exit would cause a drop in inward investment of at least 30%. That would be a significant loss for the UK.

In short, even though sterling has fallen about 12% from its August 2015 peak on a trade-weighted basis, that?s nothing yet, in my view. In early 1985 FX traders in London were preparing to hold a ?Parity Party? when GBP/USD reached 1.0000, but it never got there ? 1.0520 was the lowest closing price.

In any case, it was reported at the time that they were having trouble find a locally grown equivalent of Champagne with which to celebrate. If the UK does vote to leave the EU though, they might be able to have another go at it ? and this time, there?s plenty of British bubbly available.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc. ( Mbs-Rifan Financindo Berjangka)?

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