Wednesday 21 March 2018

Daily Market Update: Markets in turmoil as UK votes to leave the EU

A man looks at a board showing currency exchange rates outside a Bureau de Change in North London, as holidaymakers heading abroad this summer have been flocking to snap up their travel money ahead of tomorrow's EU Referendum. Photo: PA
A man looks at a board showing currency exchange rates outside a Bureau de Change in North London, as holidaymakers heading abroad this summer have been flocking to snap up their travel money ahead of tomorrow's EU Referendum. Photo: PA

Richard Ramsey

Global financial markets have been gripped by a bout of enormous volatility overnight as it became clear as counting proceeded that the Referendum was going to result in a UK vote to leave the European Union.

That outcome has been confirmed this morning, with the final result standing at 51.9% for leave and 48.1% for remain. 

The dominant theme in markets has been a huge surge in global risk aversion reflected in enormous moves across a range of instruments.  Equity markets are under extreme pressure, with the Nikkei down 7.9% overnight, and most European bourses, including the FTSE, posting heavy losses in early trading, some down over 10%.  However, as had seemed extremely likely in the event of a Brexit, sterling has taken a particularly large battering on the currency markets.  GBP/USD plunged to as low as $1.3230 overnight – levels last seen in the mid 1980s – following a staggering and unprecedented 12% collapse from its pre-count high of close to $1.5050.  Huge moves have also been seen in the Eur/GBP rate which itself at one point had spiked to almost 83.2p from pre-count levels of 76p late last night – a 9.5% plunge in the UK unit.  A Brexit outcome was also going to represent a major shock to markets, but these moves were amplified by the fact that over the course of recent days, including up to as late as 11pm last night, markets and bookmakers alike were increasingly convinced that the remain camp would win, meaning that the scale of the shock which then unfolded over the course of last night was considerably larger.

There has been some modest retracement from the extremities of the overnight moves over the past couple of hours, with the pound changing hands for around $1.39 and 80p against the dollar and euro respectively as I write.  However, we are extremely reluctant to infer from these modest reversals that the worst is over for the pound, or indeed for markets generally.  The defining feature of the post-Referendum landscape is uncertainty.  As we noted yesterday for example, one major source of uncertainty relates to what the UK-EU relationship (and indeed that between the UK and the rest of the world) will end up looking like after the UK leaves.  But the difficulty here is that there will now be a long period of time (likely to be at least two years) while the UK Government negotiates its exit relationship with the EU.  That is, it is going to be some considerable time before any clarity emerges on the UK’s new trading arrangements with the rest of the world.  This has consequences for the UK itself obviously, but also for its key trading partners including the rest of the EU, and makes it extremely difficult for markets to discount the implications of whatever outlook those uncertain future relationships might imply.  Moreover, today’s result also amplifies concerns about political risks, both in the UK and beyond.  The UK PM David Cameron has already resigned and is set to hand over to a new leader by the Conservative party conference in October, but the potential political ramifications don’t end there.  Investors will also be focused on the potential consequences for sustained political stability in the United Kingdom itself (e.g. Scotland voted to remain in the EU) as well as in the wider European Union where there is now a growing risk of greater euroscepticism across the continent. 

Thus in our view, Irish treasurers are likely to face a sustained period in which markets in general and sterling currency markets in particular are likely to remain highly volatile, underscoring the importance of maintaining an active approach to the management of currency exposures.  In particular, we would not at all rule out the possibility that sterling could fall to new lows in the period ahead and wouldn’t be surprised to see Eur/GBP move towards 85p or higher for example.

Sustained sterling weakness and further volatility would obviously pose material challenges for Irish exporters to the UK (especially Irish-owned exporters for whom the UK market accounts for some 40% of their foreign sales).  Irish businesses that source imports from the UK will see the reverse impact with the weakness of the UK currency presenting opportunities to source imports more cheaply.  Plus, there could well be opportunities for Ireland to secure additional FDI from non-EU investors seeking a business-friendly, English-speaking base from which to serve the EU market now that the UK will be leaving.  Also helpful is the fact that the euro has weakened against the dollar, currently showing a decline of about 2% over the past 24 hours to trade at $1.1120, in the process helping to improve the competitiveness of US-destined exports as well as the attractiveness of Ireland to US FDI investors.  Moreover, it is extremely important to remember that for the foreseeable future– at least for the next two years as negotiations around the terms of departure proceed – nothing will change in relation to trade relations between the UK and Ireland or any other member state.  That is, for some considerable time, there will be no rule-changes in relation to tariffs or customs-clearing or other regulations governing intra-EU trade patterns that could hamper existing trade flows and patterns.  So in some respects, it is BAU today compared to yesterday for the many British, Irish and other EU firms trading with each other. 

But, taking a longer term view, the UK has clearly yesterday decided to fundamentally overhaul its relationship with the EU, meaning there is simply no clear line of sight as to what the future will hold in these respects.  It is partly this resulting huge step-change in uncertainty to which markets are reacting so adversely and which is very likely to exert a meaningfully negative impact on the UK economy as well as those of its main trading partners, including Ireland, in the period ahead, albeit that the Irish economy’s very strong momentum (growth had been expected at around 5% this year) offers a very helpful buffer against the Brexit shock.  In the meantime, we should expect soothing noises from the world’s major central banks as they seek to reassure investors and the wider public that they stand ready to act as needed with additional liquidity, and potentially additional monetary stimulus, as needed to contain and manage the fallout.  Indeed, the Bank of England has already issued such a statement a short while ago, highlighting its extensive contingency planning for this scenario, the resilience of the UK financial system (helped by substantial capital and liquidity buffers) and its willingness to provide further support to the system and wider economy if needed.

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