In the wake of the surprise UK EU referendum vote, currency markets went haywire.
After initially surging, the British pound crashed to a 30-year low against major currencies as the tally of votes reflected a country desiring to 'leave' the European Union (EU). This was not expected by most experts.
Kit Juckes, a currency strategist for Societe Generale, warns that the decline in the currency may not be over.
“The UK economy enters a period of huge uncertainty – and weakness as a result - and despite the 9.8% fall in GBP/USD that we have seen overnight, there is a grave danger of further weakness in the weeks ahead," Juckes wrote in a note to clients. "Indeed, the view of policymakers will be that a weaker pound is a vital economic shock absorber.”
In advance of the vote, economists predicted that the first line of defense against a "leave" vote would be central bankers unleashing easy monetary policy.
"In the event of Brexit, an important cushion likely will come from a commitment by central banks to limit the negative consequences for growth, inflation, and financial stability," JPMorgan's Bruce Kasman said last Friday. "If the UK votes to leave this coming Thursday, we would expect the Bank of England and ECB to make statements on Friday expressing their determination to use all instruments available to deliver on their mandates. Exactly what they do will depend, in the first instance, on the severity of the financial market response. We would expect the Bank of England to take its policy rate down to zero by the end of the summer at the latest, but it could be quicker than that."
All of this stimulus would be intended offset at least some of the market volatility that may be exacerbated by economic and policy uncertainty.
"Initially the Bank of England will focus on liquidity and the stability of the financial system but in due course, monetary policy is likely to be eased too," Juckes said. "We continue to look for GBP/USD to trade in a 1.30-1.35 range for now (i.e. a little lower than here) and eventually, towards 1.20-1.25."
A weaker British pound makes British goods cheaper to foreign buyers, which is a win for British exporters. And for companies with significant overseas operations, any money that's converted back to the pound will suddenly yield more pounds than previously expected.
Overall, the consequences of this week's events are expected to be a net negative for the global economy.
“The global economic effects will be modestly negative, which would matter less were the global economy in better shape,” Juckes said. “But UK voters are not the only ones to demand change… We’ll write a lot about all of that in the days ahead but today’s conclusion is that the economic fall-out will be biggest in the UK but not negligible in the EU. The political fallout will be felt more widely and that is what will sustain risk aversion for now.”