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08 Jul 2016

Exchange Rate Warning! Pound Drops to Dollar?

The British pound sterling continues to lose strength as financial markets react to the lack of any government plans after the UK’s vote to leave the European Union. If there is one thing the markets dislike it is uncertainty- precisely what will be hovering over the UK all summer through until September.

At one stage on Wednesday July 6, the pound exchanged for just below $1.28 in trading in Asia, before creeping back up. This is its worst value in 31 years, leaving the UK currency languishing at 13 percent lower than it had been before the big vote.

Against the euro, recently the pound sterling hit a three-year low. The euro is also weakened against the dollar on worries the Brexit will curtail the already fragile Eurozone economy. While the UK drifts, leaderless- still anticipating the first female Prime Minister since Margaret Thatcher, a respected financial market ‘thought leader’ insists that politicians put aside party differences and put together Brexit plans. Unless they do this effectively we’ll see the pound sterling exchange on parity with the US dollar.

Allianz’s Mohamed A. El-Erian

Egyptian-American Mohamed A. El-Erian, served as CEO of Pimco (the American multinational investment management firm) until 2014, then taking his position as the chief economic adviser to Allianz, Pimco’s parent company. With around 1.3 trillion euros , (or 1 trillion pounds) under his management, El-Erian is a well-regarded, politically unbiased economic information source.

Reuters has reported a telephone interview with El-Erian who warned that UK politicians must urgently organize a credible economic free trade agreement – which he termed a “Plan B”, otherwise Britain faced greater structural uncertainty, lower economic growth and a higher risk of recession after the referendum vote. “After the Brexit referendum, the UK has to urgently get its political act together, including a new Prime Minister who can negotiate effectively with the EU,” El-Erian said.

Political Turmoil Leading to Economic Consequences

In the vacuum already felt in the absence of any leadership by David Cameron- indeed he’s seemingly evaporated since announcing his resignation, political upheavals have taken centre stage, but no one has stepped forward with a plan for the course ahead.

The vote threw Britain into its worst political crisis in modern times, with both political parties in turmoil. This has left investors spooked about how the future relationship with the EU will be shaped. Sterling has taken the brunt of the impact, seen plummeting to a 31-year-low.  It was trading at $1.50 on June 23, the day of the EU referendum. El-Erian has said that that pound could drop to parity with the dollar or strengthen depending on the political response to the current challenges.

Parity with the Dollar

El-Erian said that Plan B depends on the politicians in London and the Eurozone, noting that as of yet no one was willing to initiate taking any responsibility for economic governance. This vacuum of uncertainty is hampering inflows of investment exacerbated by the Bank of England being unable to provide the anchor of higher interest rates.

“Think of sterling as facing a double whammy with no strong anchor,” El-Erian said.

He indicated that we’ll either see the sterling drop or rise when negotiations between the UK and EU are finally underway: “The future value of sterling is a function of how and how quickly the structural uncertainty is resolved  – if Plan B is delayed or it doesn’t involve much of a free trade setup with the EU, it is not inconceivable for sterling to go to head to parity with the U.S. dollar,” he said.

“If, however, there is agreement between the UK and its European partners on a new arrangement that allows for sufficient free trade access, sterling could end up appreciating from its current levels.”