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22 Feb 2016
Brexit: What a drag (on sterling) - SocGen
Kit Juckes, Research Analyst at Societe Generale, suggests that the EU ‘Brexit’ referendum is going to dominate media debate over the next 124 days.
Key Quotes
“Opinon polls show a small lead for the ‘out’ camp, but a large body of ‘undecideds’ will decide the eventual outcome. Bookmakers still favour the UK remaining in the EU. The level of debate is appalling, in my view and the suggestion this morning that being in the EU somehow makes the UK more vulnerable to terrorist attack may have been the silliest argument I’ve heard so far. When asked, my opinion is that leaving the EU may make some people happier, but it is definitely a drag on growth. How much of a drag is open to debate but the figures Brian Hilliard published last year, a ½% per annum drag on growth in the UK and a ¼% dag on the Eurozone, are a good starting point.
The impact on sterling has been felt almost exclusively through interest rates, so far. Chart 1 shows the 2-year UK/US rate differential and GBP/USD, still marching broadly in step. The prospect of a vote on EU membership has clearly played a part in driving down UK rate expectations, and to that extent exit is partly priced but we’d stick by a view that if the UK leaves, rates would not rise even as sterling fell, at any point in this cycle. The Gilt curve would steepen but the currency would probably fall further than implied by relative rates alone.
Sterling looks weak relative to the net short, but if the reaction to the debate starting in earnest is a build-up of a bigger short position, I’d expect further currency softness.
Overall, I think we are likely to see further sterling weakness ahead of the vote itself, as the debate rages and uncertainty undermines confidence. I can’t imagine the opinion polls moving decisively enough in either direction for clarity to emerge before June 23. In the process, I expect to see GBP/USD break 1.40 and EUR/GBP break 0.80 between now and then – possibly both at the same time. On a ‘Brexit’ I’d look for GBP/USD to trade to 1.30, at least.”
Key Quotes
“Opinon polls show a small lead for the ‘out’ camp, but a large body of ‘undecideds’ will decide the eventual outcome. Bookmakers still favour the UK remaining in the EU. The level of debate is appalling, in my view and the suggestion this morning that being in the EU somehow makes the UK more vulnerable to terrorist attack may have been the silliest argument I’ve heard so far. When asked, my opinion is that leaving the EU may make some people happier, but it is definitely a drag on growth. How much of a drag is open to debate but the figures Brian Hilliard published last year, a ½% per annum drag on growth in the UK and a ¼% dag on the Eurozone, are a good starting point.
The impact on sterling has been felt almost exclusively through interest rates, so far. Chart 1 shows the 2-year UK/US rate differential and GBP/USD, still marching broadly in step. The prospect of a vote on EU membership has clearly played a part in driving down UK rate expectations, and to that extent exit is partly priced but we’d stick by a view that if the UK leaves, rates would not rise even as sterling fell, at any point in this cycle. The Gilt curve would steepen but the currency would probably fall further than implied by relative rates alone.
Sterling looks weak relative to the net short, but if the reaction to the debate starting in earnest is a build-up of a bigger short position, I’d expect further currency softness.
Overall, I think we are likely to see further sterling weakness ahead of the vote itself, as the debate rages and uncertainty undermines confidence. I can’t imagine the opinion polls moving decisively enough in either direction for clarity to emerge before June 23. In the process, I expect to see GBP/USD break 1.40 and EUR/GBP break 0.80 between now and then – possibly both at the same time. On a ‘Brexit’ I’d look for GBP/USD to trade to 1.30, at least.”