Brexit and its effect on the British Pound and Markets

Today, British voters made one of the biggest political and economic decisions that the country has faced in recent history. By special referendum, the British public decided to have the country exit the European Union. The referendum stated that its goal is to have the country officially out of the EU in 2 years, by 2018. Since the release of this news, markets across the globe have been in turmoil, and the British pound sterling has taken a serious dive.

 

The decision to exit the European Union was an incredibly close one, with the Leave camp garnering 51.9% of the vote. This decision came as a shock to many, as most predictors had bet that the country would vote to remain. Online polls taken Wednesday and Thursday showed 54% support for Remain, and a separate poll taken the day of the referendum showed 52% support for Remain. Some put the likelihood of Remain winning even higher, such as popular betting exchange Betfair, which calculated a 94% chance that the verdict would be Remain. The strength of the belief that Britain would remain made the results all that much more upsetting for markets when it was revealed that Britain would in fact leave.

 

The immediate effect of the Brexit decision on the pound was quite unpleasant, with the currency taking a heavy dive, hitting a 31-year low on currency markets. This plummet constituted the biggest one-day loss the pound has seen since becoming a free-floating currency. When polling stations closed, one pound was trading at $1.50 American. By the time the votes had been counted and word had spread that Britain would be exiting the EU, the pound had taken a drop of more than 10%, down to just $1.33. It has since rebounded slightly, trading at around $1.37. The pound also saw a 7% drop against the Euro and a 10% drop against the Yen.

 

The Brexit decision, and the subsequent loss of value for the pound, are certain to have many effects at home for Britain. The country can expect to see inflation rise, first on imported goods and eventually spreading to the rest of the economy. Because the Bank of England has a legal obligation to keep inflation as close to 2% as possible, a rise in interest rates may also come to Britain if the pound’s fall is enough to push inflation any higher than this. The potential increase in interest rates, however, will likely be small, as the likely troubling economic times in Britain’s future will make the Bank of England skittish about raising interest rates.

 

It’s unclear when, or even if, the pound will see a rally back to its former value. Only time will tell, although it would appear that any gains for the pound won’t be coming for a while, as Britain is likely to be going through a period of heavy uncertainty the next 2 years, while it transitions out of the EU. This uncertainty has had an effect on not only the country’s currency, but on its markets as well.

 

In fact, markets around the world saw losses following the Brexit announcement, with the S&P 500 opening down 5%. Other US markets dropped as well, with the Dow dropping 520 points after the announcement, and the Nasdaq dropping 3%. Asian markets also saw losses. Hong Kong’s Hang Seng dropped 2.9%, and Japan’s Nikkei saw a massive drop of 7.9%. Closer to home, a broad gauge of European blue-chip stocks index saw a drop of 6.5%. And at home, Britain’s benchmark stock index saw a drop of nearly 9%.

 

Even outside of stock indexes, losses were seen in financial markets. The international oil price gauge, Brent, saw a nearly 5% drop. Banking stocks as well took a significant hit across Europe, with multiple lenders across Europe taking a 15% drop. A bit of good news presented itself, however, as central banks in the US, UK and across the Eurozone said they were ready to provide support if need be. With the sorts of steep declines that banking stocks have been posting, however, this proposed support is merely a thin ray of light in an otherwise bleak picture.

 

While British voters think exiting the EU will be good for the British economy in the long run, the immediate impact certainly has been a negative one. In addition to the pound’s massive drop in currency markets, many investors are planning on pulling out of Britain, or at the very least pausing expansions into the country. Whether you are for or against Britain leaving, what is certain is that the next 2 years, during which time Britain will make the transition out of the EU, will surely be marred with uncertainty. And uncertainty is probably the most reviled word for investors.

 

This tidal wave of uncertainty has got investors very worried, and not sure how to respond. Many are turning to safer assets, such as gold, which saw an initial rise of 8.1% today as a result of the Brexit news, and eventually calmed down a bit ending with a 4% rise. This of course is expected, as investors often flock towards gold when economic and political uncertainty becomes too much. The future for gold may indeed be bright, as uncertainty will continue to persist in global markets while Britain makes its transition out of the EU, and the world learns to deal with an EU-removed Britain. Gold has already been having a good year even before this latest jump, being up 24% for the year already.

 

It’s not exactly clear what the future holds for Britain and the pound. Perhaps the majority who voted to leave will see the stronger growth they were hoping for. Or perhaps the Remain camp were right all along, and Britain’s exit of the EU will make the British economy worse off. There really is no way to know for sure. What we do know for sure, though, is that Brexit has had an initial effect of dragging down the pound against other currencies, as well as caused losses in most major markets. What is also known is that the next 2 years will be largely defined by uncertainty for Britain, as the country makes the transition out of the EU.