The EU Referendum & The Importance of Managing FX Risk

The EU Referendum and Importance of Managing FX Risk

With the UK’s EU referendum looming ever closer, it seems you can hardly turn on a television or glance at a newspaper at the moment without being bombarded by politicians and economists telling you why a vote to ‘remain’ or a vote to ‘leave’ is the ‘right thing to do’. With that in mind we are certainly not about to start telling you how you should vote on the 23rd June and we don’t wish to speculate on the medium to longer term implications. However we do feel it is vitally important that you are aware of the potential implications in the immediate aftermath of any outcome.

 It’s safe to say that the one thing all commentators agree upon is the sizeable uncertainty surrounding ‘Brexit’ and the major effects on the currency markets, with Pound Sterling understandably being at the epicentre of the currency storm. You need look no further than the impact felt when Boris Johnson decided to throw his hat into the ‘Leave’ camp for proof of this. In the aftermath of his shock announcement and with ‘Brexit’ becoming more of a reality, Sterling suffered its biggest one day fall against the US Dollar since 2010 and the Pound was as weak as it had been since April 2014 against a basket of currencies. Just yesterday the Bank of England sounded their clearest warning to date regarding the ‘significant risks’ to the MPC’s economic forecasts posed by the referendum. The BOE went on to state that: "A vote to leave the EU could materially alter the outlook for output and inflation, and therefore the appropriate setting of monetary policy."  

 So what, in ‘theory’ at least, can we expect to happen should the UK public decide to ‘Remain’ or to ‘Leave’ the European Union?

 What to expect if we vote to ‘Remain’ in the EU

Should the UK vote to remain in the EU it is widely expected that Sterling will rally in the FX markets. The extent to which Sterling strengthens will in part depend on how close the polls are in the run up to the vote. The most recent YouGov poll has the ‘Remain’ camp ahead by just 2points. Should that gap fail to increase or indeed narrow further it will naturally generate more uncertainty as the deadline looms and as such further weaken Sterling. In this scenario we could expect a large correction and aggressive Sterling rally. Conversely, and seemingly unlikely at the moment, should the polls start to show a clear lead for the ‘Remain’ camp we would expect to see Sterling making gains ahead of the vote and as such any post-result rally would be more subdued. 

 What to expect if we vote to ‘Leave’ the EU

In the event of a vote to ‘Leave’ there is a general consensus that Sterling would sell-off. However this would be an unprecedented event and the extent of any sell-off would be an unknown quantity; as such the predictions from banks and financial institutions vary wildly. One extreme shows Goldman Sachs warning that a ‘Brexit’ vote could slash Sterling by 20%. Credit Suisse also paint a bleak picture predicting Sterling to trade as low as 1.2050 and 1.2000 versus the Euro and US Dollar respectively. At the other end of the spectrum Bank of America believe FX markets are more prepared for the EU referendum, unlike the Scottish equivalent, and therefore a large part of the premium will already be built in. Ultimately a vote to ‘Leave’ would be negative for Importers and buyers of foreign currencies, but on the flip side it could prove favourable for UK Exporters as our Goods and Services will become relatively cheaper for overseas buyers.

 Importance of Managing FX Risk

As with most high profile and high risk events such as the EU referendum, the outcome will prove good for some and unfortunately not so good for others. In the run up to the referendum and in the immediate aftermath there could be opportunities for both Exporters and Importers, and for Buyers and Sellers of Sterling. The key to capitalising upon these opportunities, or to limit any potential losses, will be down to effective FX risk management. Knowing exactly how your business or personal currency requirements are going to be impacted by the differing outcomes of the vote is vital to using the correct FX strategy to limit currency exposure. This is exactly the situation where the use of a good FX broker can be invaluable. At OSTC FX we will be working as close as ever alongside our clients to enable them to navigate their way through this particularly turbulent period and ensure they are best positioned to succeed whatever the result.   

 Strategy Suggestions

Importers – For importers who are paying suppliers in foreign currencies, the use of a forward contract would be advisable if your instinct tells you that a vote to ‘Leave’ could prevail. In such a scenario you could look to capitalise upon the exchange rates before Sterling potentially becomes weaker in the event of a vote to ‘Leave’ the EU.

Exporters – If you receive foreign currencies in payment for your goods or services that subsequently need to be exchanged back into Sterling, the use of a forward contract ahead of the referendum could be crucial. If (And we must stress if) you have a strong feeling that a vote to ‘remain’ could prevail then by locking in an exchange rate ahead of the referendum you could capitalise upon a weaker pound thus securing yourself more Sterling funds than you may otherwise receive following a vote to ‘remain’ in the EU.

 Brett Thomas, Foreign Exchange Dealer.

Phone: +44 (0)1792 720873

Email: [email protected]

Website: www.ostcfx.com