Spartan FX GBP/EUR rate update
Over the past few days we have seen sterling fall to a 28 month low versus the Dollar and a two year low against the Euro as fear and uncertainty that the UK is heading for a no-deal Brexit continues to increase. The new Prime Minister Boris Johnson has always stated that he would leave the EU with or without a deal by the 31st October.
So what has changed over the last week to make the Pound slide 2.5% against most of the major currencies, firstly Boris Johnson’s has been busy sculpting his new Government, with all the major positions being handed to fellow Brexiteers there should be very little resistance and a lot of support within his party for a no deal Brexit. There are of course rumours that the UK could leave the single market over a 2 year period which has provided some respite but this would very much go against the new PM’s promise to deliver Brexit without any further delays or extensions.
Secondly, despite the new prime minister pledging to ‘hold out a hand’ and ‘go the extra thousand miles’ to secure a new deal with the European Union, the negotiations seem very unlikely given that neither party is willing to discuss the matter, let alone negotiate. One of the major issues for any negotiations has always been the Irish backstop, Mr Johnson has commented that the backstop is no good, it's dead, it's got to go. The EU’s leaders have said that it would be unwilling to re-open negotiations on the current withdrawal agreement after Prime Minister Boris Johnson demanded the removal of the Irish backstop. Boris Johnson responded by commenting that he will sit down with the EU leaders for Brexit talks when they indicate that they are ready to shift position on the divorce deal, otherwise Britain will prepare for leaving without an agreement. With neither party seemingly willing to change their views the chances of a last-minute deal are slim. The Confederation of British Industry (CBI) also commented that the UK and the European Union are not ready for a no-deal Brexit and they have not made the appropriate preparations, which has further increased the fears of the negative impact Brexit could have on both economies in the future.
Whilst we expect to see the Pound on the back foot in the short term we could see a strong reversal in the GBP/EUR exchange rate at some point in the future. Recently we have seen Mario Draghi the head of the European Central Bank (ECB) comment that the European economy is struggling and inflation remains below target. Draghi said that they have not ruled out the possibility of further interest rate cuts and re-introducing the QE programme to help stimulate growth. When Europe first introduced QE the Euro weaken significantly and fell 6% versus the Pound over a few months and continued to slide over the following year finally reaching a high of over 1.43. If the Pound does fall significantly following Brexit it will make UK exports far more competitive than Europe’s to the rest of the world which could further hurt European growth. This could force Europe to initiate a new QE programme to help weaken their exchange rate and stimulate growth, whilst this is not guaranteed it would certainly be a major factor in counteracting the GBP/EUR drop we would expect from a hard Brexit.
One other major problems for the EU is that even if they want to do a deal with the UK for the good of their struggling economy, they cannot be seen as giving a good deal to the UK, as it could open the door for other countries wanting to leave the EU in the future. Europe has enough problems with Brexit and a struggling economy without wanting to reignite fears of contagion across Europe. If we did see other countries leaving EU and the single currency in favour of returning to their own currency in the future, Brexit would look like a fairly simple problem compared to what Europe could face next. If the UK was to leave and flourish as a result, contagion may be an issue that the EU has to face at some point one way or the other as other countries may also decide they are better off outside of the EU.
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