Brexit shines spotlight on GBP-EUR, traders flee to safe havens

LONDON (ICIS)–The UK referendum on EU membership is drawing attention to the region’s currencies, and their economies’ weaknesses, prompting a flight into what is perceived as less risky investments.

TRADERS FLEE RISKY ASSETS

“The potential Brexit means a huge amount of uncertainty for investors, who are offloading risky assets in favour of safe havens,” Alastair Archbold, FX Manager at Foremost Currency Group said.

“The global equity markets have endured a rough few sessions. Among other things, the rise in risk loathing is due to concerns about the economic implications of a potential exit of the UK from the EU. In recent days, Brexit concerns have intensified,” Fawad Razaqzada, Technical Analyst at Forex.com and City Index said.

POUND UNDER SCRUTINY

The sterling is under scrutiny by forex traders and volatility has consequently risen to levels last seen in 2008.

 “Volatility in the pound has risen to its highest level since the financial crisis in recent days; the pound has dived yet again against the dollar, and along with the Mexican peso is one of the world’s worst performing currencies so far this year,”  Kathleen Brooks, Research Director for City Index said.

Brooks predicts the vote is likely to set off manic trading in the pound once the exit polls are released late on Thursday 23 June, and through to the announcement of the formal results on Friday morning.

“The referendum is merely shining a light on the UK economy, warts and all. The spotlight has revealed the UK’s economic weaknesses, which is helping to accelerate the decline in the pound and other UK-based risk assets. This should be worrying for pound bulls, as things may not return to ‘normal’ even if we vote to remain part of the EU,” Brooks said.

GBP-EUR one month currency rate Source: XE.com

GBP-EUR could fall by up to 20% should the UK exit EU:
Alastair Archbold, Foremost Currency Group

“Sterling is seen as weaker in the event of a Brexit, so the gains in the Leave vote have impacted sterling quite heavily and continue to do so,” said the head of FX Strategy at Saxo Bank, John Hardy.

“If on polling day voters decide to vote for the status quo, I would expect GBP/EUR rates to recover to €1.34/€1.35 mark,” Archbold said.

EURO UNDER INTENSE PRESSURE

Analysts expect the UK economy to face a rough time if voters decide to quit the EU, but it will be negative for the European economy too.

 “With the latest referendum polls showing the Leave camp extending their lead, funds are moving out of risky EU currencies, and into perceived ‘safe’ currencies such as JPY and USD,” Archbold said.

“The interesting thing over the last 1-2 weeks has been a clear impact on the euro from Brexit contagion, as EURCHF has weakened sharply and EURJPY even more so – the latter at its lowest levels in over three years,” said John Hardy.

“It should be noted that a ‘Brexit’ would magnify the political weakness in the EU, and raise the question of other EU members holding their own referendums, which could also weaken the euro significantly,” said Archbold.

SAFE HAVEN INVESTMENTS

“Evidently, traders have been piling in on safe haven assets like gold and silver, yen and benchmark government bonds, causing their yields to fall to dangerously low levels. Yields on the 10-year German bunds have dropped below zero for the first time ever, while in Japan bonds with maturities up to 15 years yield zero or less,” Razaqzada said.

“The US dollar has staged an impressive rebound in recent weeks, and, interestingly, the Japanese yen is also rising. This is worth noting, we don’t often see the yen and the dollar rise at the same time, which tells us that FX traders are nervous,” Brooks said.

GBP-JPY, EUR-JPY currency rates respectively Source: XE.com

GBP and EUR weakens against JPY

GBP-USD, EUR-USD currency rates respectively Source: XE.com

GBP and EUR weakens against USD

The impact of the rising US dollar has been felt in the crude oil futures market where prices have dropped back below the $50/bbl mark.

“The USD has risen sharply against the pound recently as the Brexit vote has gained ground, but that has more to do with sterling weakness than USD strength,” said Hardy.

Investor funds moving out of the euro and the pound to safe havens is partly behind the current US dollar strength.

“This has strengthened the USD against other currencies, however gains for the dollar have been limited due to the global financial climate making it unlikely the FED will be raising interest rates any time soon,” said Archbold.

Photograph: James Gourley/REX/Shutterstock