Chart of the Week: The Penny Has Dropped

Last week, sterling hit its lowest level in more than 30 years against the US dollar as fears of a ‘hard’ Brexit and a ‘fat finger’ trade both took their toll. In our view, it has further to fall, perhaps significantly if Brexit were to open the trapdoor under sterling.

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In the early part of last week, the pound was knocked by Prime Minister Theresa May’s announcement that Britain will trigger Article 50 — the legal notification that the UK will begin proceedings to leave the EU — no later than the end of March next year. This, combined with rhetoric from the Conservative Party Conference suggesting that the government will take a hard line on immigration even though EU officials have said that the UK’s access to the Single Market will be curbed, stoked fears of a ‘hard’ Brexit. Sterling was then hit by a ‘flash crash’ on Friday, during which it fell by over 9% against the US dollar. Friday’s move is likely to have been caused by either a ‘rogue’ algorithmic trader or simply a ‘fat finger’, but sterling closed the week down 1.4% against the US dollar — highlighting its vulnerability.

Recognising that there was increasingly little hope of a near-term resolution and that uncertainty would prevail for months, if not years, we argued in July that sterling would continue to depreciate. At that time, we also suggested that the UK’s reliance on the kindness of strangers to fund its record current account deficit left sterling vulnerable. We maintain that view, and argue that it could fall much further in the medium term if Brexit were to open the trapdoor under sterling. Indeed, while it is fair to say that the period of panic in the immediate aftermath of the Brexit vote, particularly on the part of consumers, was short-lived, we see little reason to believe that the medium-term implications of the Brexit vote are any less severe than we anticipated back in July. The serious negotiations that will follow the triggering of Article 50 have not yet begun, and uncertainty is set to prevail for years. The response of firms, particularly in terms of investment, will be key.