British Pound End of Year Outlook: Will the Crash Continue?

The United Kingdom’s decision to quit the European Union on June 23 set in motion the biggest ever plunge in the British pound. Nearly five months later, the pound has dropped more than 16% against the US dollar, at one point reaching its lowest level in 168 years.[1] The outlook might not be much better, as investors monitor progress toward a hard Brexit and higher US interest rates. Both developments might prove detrimental for the pound.

Pound sterling has staged a more than 300-pip recovery against the dollar this month after Britain’s High Court ruled that the government cannot begin the Brexit process without a vote from Parliament. The ruling deepened the United Kingdom’s division over EU membership and boosted the pro-EU camp’s morale about the future of Brexit negotiations. Without parliamentary approval, Prime Minister Theresa May could face roadblocks implementing a “hard Brexit.”

Britain has already said it will appeal the decision, with Prime Minister May confident of overturning the court ruling. So far, the Conservative government has given little away about its plans for UK-EU relations.

“While others seek to tie our negotiating hands, the government will get on with the job of delivering the decision of the British people,” May said in a statement earlier this month.

“It was MPs who overwhelmingly decided to put the decision in their hands. The result was clear. It was legitimate. MPs and peers who regret the referendum result need to accept what the people decided.”[2]

The outcome of the appeal will impact whether the Conservatives can trigger Article 50 of the Lisbon Treaty by the end of March as was previously planned. Article 50 is the mechanism that allows member states to withdraw from the EU. Therefore, the pound’s immediate outlook may depend on whether May’s original hard Brexit timeline could be established.

The British pound’s outlook also depends on the performance of the US dollar, which could strengthen significantly following the conclusion of the Federal Reserve’s two-day policy meeting on December 14. In its November statement, the Federal Open Market Committee (FOMC) said “the case for an increase in the federal funds rate has continued to strengthen,” potentially setting the stage for a December rate hike.[3]

Dollar bulls were also reassured by upbeat October jobs data, which pointed to a strengthening US economy. Employers added 161,000 nonfarm jobs in October, as the unemployment rate dipped to 4.9%. A measure of wage inflation known as average hourly earnings rose 2.8% in the 12 months through October, the fastest in seven years.[4]

Traders are also doubling down on a December rate hike, based on the latest Fed Fund futures prices, which show a more than 75% probability of liftoff next month.[5]

Regardless of these two variables, the pound may remain lower for longer as Britain’s transition out of the EU evolves over time. The British economy is also expected to slow significantly over the next two years, as Brexit influences everything from business spending to consumer confidence. The Bank of England (BOE) is being especially cautious, having already slashed monetary policy and boosted stimulus spending. The Bank has not shied away from promising more easing should Brexit weigh further on the economy.

Sterling faces an uphill road, and that might not change before the end of the year.

[1] Mehreen Khan (October 12, 2016). “Pound slumps to 168-year low.” Financial Times.

[2] Reuters (November 6, 2016). “Theresa May: Parliament must accept referendum result and deliver Brexit.” The Guardian.

[3] Federal Reserve (November 2, 2016).

[4] Sam Fleming and Adam Samson (November 4, 2016). “US wage growth accelerates at fastest pace since 2009.” Financial Times.

[5] CME Group. FedWatch Tool.

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