The exchange rate of the pound collapsed against major currencies following the latest news about Brexit developments pointing towards a no deal outcome. At the time of writing, a week after the event, the pound exchange rate remains at 1.096 against the euro, and at 1.297 against the dollar, 9% and 3.7% lower from its 12-month peak, respectively.
In the past five years, the UK’s economic performance and tight monetary policy may have managed to mitigate losses of the pound against major currencies, but now they appear more likely to provoke a downward trend. The current exchange rate of the pound appears to have already incorporated the possibility of a no deal Brexit since last week, with any falls to come driven by the vulnerable state of the economy.
Unless a substantial trade agreement that could improve economic confidence is reached before the end of the year, the pound is set to see bigger losses against the euro and dollar, which are likely to be strengthened.
Looser monetary policy following a negative economic outlook will put pressure on the pound
In the last meeting of the monetary policy committee of the Bank of England (BoE) on 17 September, cutting base interest rates further below 0.1% was considered. This instantly reversed the gains of the pound against the euro with the pound-to-euro and pound-to-dollar exchange rates instantly falling from 1.1 to 1.091 and 1.297 to 1.288, respectively.
This cutting of interest rates to provide more stimulus will become more likely given the end of the furlough scheme in October and the recent tightening of lockdown measures. Economic recovery is expected to lose steam over the coming months as consumer spending falls and unemployment rises.
In that event, the fall in the price of the pound would not only come from the erosion of the value of UK government bonds, but it would also come from the loss of confidence of investors on the UK economy.
It appears unorthodox for the BoE to maintain interest rates higher than the ECB and FED, which have their policy interest rate stuck at zero, when the UK economy is expected to perform worse than those of Euro Area and the US.
The euro and dollar can only go up in the mid-term
Expectations of a further cut in interest rates from the European Central Bank given the appreciation of euro against other major currencies and a drop in inflation in August, were proven to be unfounded. The Euro area economies have posted signs of recovery, with lower than expected GDP contraction in the second quarter of the year providing some confidence, preventing the ECB from easing monetary policy at present.
In the case of the US, monetary policy is set to be a stable parameter, with the FED signaling that interest rates are set to remain at zero for at least three years. Signs of an upside-down v-curve of unemployment rate, which continues to fall in spite of further stimulus is a positive message.
In fact, it is political uncertainty that is the most destabilizing factor for the US economy and the dollar at present, but that is expected to end after the presidential elections in November.