The surprise outcome of the 2016 United Kingdom Brexit Referendum sent valuations of the British pound sterling (GBP) into chaos. Upon the final vote tally coming in at 51.9% for "leave" to 48.1% for "remain," the voting public showed its support of the U.K. withdrawing from the European Union (EU). The aftermath of the Brexit vote made it clear that a new era for both the U.K. and GBP had officially started.
A majority of the financial community believed a vote in favour of Brexit was improbable at best. The position was not unfounded, with the final electoral results showing that much of the U.K. supported ongoing membership in the EU:
Fueled by concerns over fair trade, immigration and national security, England proved to be the deciding factor in the U.K.'s exit from the EU. Boasting the largest portion of the U.K.'s electorate, England's edge of 1.9 million votes was the primary reason the "leave" option prevailed.
Surrounded by political and economic uncertainty, currency markets facing the GBP reacted negatively to the idea of a fully autonomous U.K. Pricing volatility reached dangerous levels for the pound sterling, and values fell more than 10% in the hours after the vote was made final.
This currency market fallout marked the beginning of a tumultuous period for the GBP. Unique challenges have presented themselves throughout the process of the U.K. formally exiting the EU. From the Article 50 enactment of the Lisbon Treaty to a pending Scottish Independence Referendum, the transition following Brexit has brought the future status of the GBP into question.
The Beginning Of The Brexit Transition: Enactment Of Article 50
Article 50 of the Lisbon Treaty is the section of EU law that outlines the process for a member state to formally exit the union. Article 50 includes five specific provisions:
- Any Member State may decide to withdraw from the Union.
- Upon the Member State notifying the Union of its intention, an agreement shall be negotiated between the State and Union. It will specify arrangements for the State's withdrawal and future relationship with the Union.
- Agreed upon Treaties between State and Union will cease to apply two years after date of entry into the withdrawal agreement unless extended through unanimous consent of Member States.
- The Member State shall not participate in the discussions of the European Council.
- A State may ask to rejoin the Union, subject to the procedure in Article 49.
In November 2016, a legal challenge halted the triggering of Article 50, citing the need for a Parliamentary vote to first be conducted. The challenge was upheld, prompting an instant 1.2% gain in the GBP against the United States dollar (USD). The market's optimism over the U.K. potentially staying in the EU lasted for several months until spring 2017.
In March 2017, Parliament voted to pass the Article 50 bill, which effectively cleared the way for invocating said article. Upon Parliament's decision hitting the news wires, the GBP dove more than 0.7% against the USD. The falling GBP was a product of renewed scepticism over the future of U.K. economic prowess and procedural uncertainty surrounding the Brexit transition process.
Article 50 was officially invoked by British Prime Minister Theresa May on 29 March 2017. When May's signed letter was received by the European Council, the two-year window for transition negotiations commenced. In the immediate aftermath of Article 50 being triggered, the GBP fell 0.3% against the USD, extending post-Brexit Referendum losses to 17.5%.
Executing The Transition: The Divorce Bill
Reaching a deal between the U.K. and EU regarding the actual conditions of withdrawal is a multifaceted endeavour. Ongoing financial obligations, the preservation of existing trade relationships and the Ireland/North Ireland border are a few items integral to the discussion.
Transition dealings officially began in November 2017 with the negotiation of the "divorce bill" between the U.K. and E.U. The divorce bill outlined a cash settlement to be paid by the U.K. in compensation for its share of existing EU spending commitments. Payments are to be made over time and are estimated at 13% of the total EU budget, upwards of £50 billion.
While some view the payment as unreasonable, economists argue that the divorce bill will actually save money in the long run. The cost of a "Hard Brexit," one with no transition deal, may cost the U.K. as much as £190 billion in economic fallout by 2030.
In the immediate aftermath of the divorce bill being announced, the GBP rallied 0.6% against the USD, reaching two month highs. The price action illustrated a common theme throughout the Brexit process: any elimination of uncertainty acted as a catalyst for gains in the pound sterling.
A Deal For Transition
On 19 March 2018, officials announced a deal governing the two-year implementation period following Britain's scheduled exit from the EU. Led by chief negotiators Michel Barnier and David Davis, the deal put to rest many of the questions surrounding completion of the Brexit process.
The transition period, or implementation phase, is set to officially begin 29 March 2019 and last until 31 December 2020. This 21-month period is meant to provide affected industries and governmental agencies adequate time to make the necessary preparations for a smooth transition. Upon its completion, permanent guidelines for future EU/U.K. relations are to be put into place.
In addition, the agreement for implementation contains several key elements designed to promote a seamless transition for the U.K.'s exit:
- The U.K. will be able to unilaterally negotiate and ratify its own trade deals during this period.
- The U.K. will still be subject to existing E.U. trade deals until 31 December 2020.
- E.U. citizens immigrating to the U.K. will be given the same rights during the transition period.
- The U.K. will receive fishing rights, but will not be able to enact new fisheries policy until 31 December 2020.
- Northern Ireland will remain in the single market and customs union to avoid a "hard border" with the Republic of Ireland.
The deal for transition is a significant step in preserving long-term U.K./EU relations. While the issues of fishing rights and the Northern Ireland border are points of contention, a majority of the economic concerns over the Brexit transition are addressed thoroughly.
Upon news of the agreement being made public, the GBP rallied considerably against the USD and euro (EUR). In the trading session following the announcement, the GBP gained 0.7% against the euro and 0.9% vs the USD. Citing an increased probability of tightening monetary policy from the Bank of England (BoE), several institutional investors raised long-term projections for the pound sterling. In turn, bullish sentiment toward the GBP crept into the marketplace.
Tumult And Surprise: Resignations Within The U.K. Brexit Transition Team
Amid tense negotiations, several leading proponents of Brexit abruptly resigned their positions on the U.K. transition team. Within a 24 hour period beginning 8 July 2018, Brexit Secretary David Davis and U.K. Foreign Minister Boris Johnson each took their leave of the process. In addition, Steve Baker, one of Davis' deputy ministers, also tendered resignation. As a result, uncertainty grew facing the GBP and terms of the U.K. leaving the E.U.
One of the primary reasons for the departures was a disagreement with U.K. Prime Minister Theresa May regarding the extent of concessions to be made during ongoing negotiations. Citing terms outlined in the Chequers memo as being "too soft" toward the preservation of U.K. interests, both Johnson and Davis elected to tender their resignations. Several items outlined in the Chequers memo are credited with undermining Johnson and Davis' desire to achieve a hard Brexit:
- Creation of a combined customs territory between the E.U. and U.K.
- U.K. obligation to police the traffic of goods to the E.U. and apply E.U. tariffs where applicable.
- Both sides were to abide by a common rulebook for all goods flowing between the E.U. and U.K.
- Assorted matters were to be handled by a "joint institutional framework."
In his resignation letter, Johnson referred to the Chequers memo as being a "semi-Brexit" and that it put the U.K. on a path to "colony status."
The sudden resignations undermined the fluidity of the Brexit process and political stability of U.K. leadership. Subsequently, the chances of a Conservative party vote of "no confidence" facing Prime Minister Theresa May increased. Also, talk of a potential snap election for the Prime Minister seat also gained steam ahead of the March 2019 U.K. departure date.
The impact that each resignation had on the pound sterling was substantial. In the case of David Davis, the GBP experienced moderately positive volatility. In the hours after his stepping down became official, the GBP rallied 0.6% against the USD and 0.3% vs the Euro.
Optimism toward the GBP proved fleeting as reports of Boris Johnson's withdrawal flooded newswires hours later. Gains made in the wake of the Davis resignation were promptly given back, with the GBP falling 0.3% against the USD and Euro respectively. Due to the timing of Johnson's abdication, the pound ended the forex session on a down note.
At their core, the departures of Davis and Johnson signalled upheaval on the U.K. side of the Brexit transition process. With the odds of a formal challenge to Theresa May's leadership growing, the GBP experienced increased volatility due to the market's perception of political risk. In fact, many currency analysts predicted a massive depreciation in the pound sterling in the event a turnover in leadership were to occur.
While the Brexit process continued to move forward amid the shakeup in transition leadership, ambiguity regarding previously negotiated terms plagued the stability of the GBP.
Deal Or No Deal?
The process of the U.K. departing the EU technically began with the enactment of Article 50. However, reaching a formal agreement regarding the terms of withdrawal proved to be a painstaking task. As a fierce debate over economics and an Ireland/Northern Ireland border ensued, resignations and missed deadlines became a regular part of the dynamic. The meeting at Salzberg illustrated the degree of political conflict present in negotiations and the pound sterling's sensitivity to each development.
During 2016, then-U.K. Home Secretary Theresa May took a nuanced public stance on the issue of Brexit, while privately lauding the benefits of Britain remaining in the EU. When May was appointed Prime Minister on 13 July 2016, hard-line "Brexiteers" began to voice concerns that her leadership was likely detrimental to the crafting of an acceptable withdrawal. Upon the initial October 2018 deadline for a deal passing, an official challenge to May's leadership became a popular notion among the Tory party in Britain. As negotiations with the EU moved forward, a growing movement for a Tory vote of "no confidence" began to gain steam.
A late-October announcement of a tentative U.K./EU Brexit finance deal reinforced May's stumbling leadership. The deal was said to prevent a hard border with Northern Ireland as well as to give London basic access to EU financial markets. This was particularly important to the markets, as more than 37% of Europe's financial assets are managed in London and worth €6.82 trillion.
Subsequently, the GBP experienced strong bullish short-term volatility. Forex traders took the news as a sign that a final Brexit deal was imminent and bid the pound sterling higher against the U.S. dollar and euro. Following the 31 October breaking news, the GBP performed well through the 1 November close against the USD and EUR:
|31 October 2018||GBP/USD||64|
|31 October 2018||GBP/EUR||89|
|1 November 2018||GBP/USD||232|
|1 November 2018||GBP/EUR||111|
Past Performance: Past Performance is not an indicator of future results.
Even though the EU/U.K. financial deal was not officially approved by Parliament or the EU Commission, the announcement suggested that avoiding a hard Brexit remained possible. With concern surrounding the future of May's leadership and a no-deal Brexit subsiding, the GBP showed strength as optimistic sentiment dominated forex participation.
Fallout From Salzburg: A "No Deal" Brexit Becomes A Possibility
The summit at Salzburg, Austria in September 2018 proved to be a turning point in the Brexit transition process. Prime Minister May sat down with leaders from the European Council to discuss a final Brexit agreement in an informal capacity.
U.K. interests sought to preserve as much sovereignty as possible, while EU representatives aimed to ensure ideal trade and border considerations for their group of 27 remaining nations. When the meeting concluded, Salzburg turned out to be a contentious gathering and one that brought the possibility of a "no deal" Brexit to the forefront.
Essentially, a "no deal" Brexit refers to the U.K. leaving the EU abruptly on 29 March 2019 without any sort of transitionary period or further negotiations. The impact of a no deal Brexit on U.K./EU relations is multifold and potentially dramatic:
- The previously outlined 21-month transition period for amendments to existing trade deals and laws, or fresh negotiations, is to be eliminated.
- A contested border between Ireland and Northern Ireland may become a reality. The EU bloc could apply pressure to Northern Ireland to enforce customs policies and immigration checks.
- U.K. citizens living in the EU, as well as EU citizens living in the U.K., would have no legal status.
- Without a formal deal, the U.K./EU trade relationship, including tariffs, would fall under jurisdiction of the World Trade Organisation (WTO).
At Salzburg, Theresa May promoted her plan for Brexit, known as the "Chequers" plan. It was based on three priorities: protecting Northern Ireland's standing within the U.K., preserving trade relations with the EU and maintaining security ties with the EU.
May's proposal did not gain traction among the European Council and faced heavy scrutiny from conservative Brexit supporters within the U.K. When taken together, the opposition signalled that a no deal Brexit may become a real possibility.
The fallout from Salzburg hit the GBP hard. As news of a riff over a hard Northern Ireland/Ireland border between May and the European Council became public, forex traders began to limit exposure to the pound. Rapid losses of 0.1% against the USD and euro ensued as the headlines out of Austria suggested that a no deal Brexit was gaining traction.
Further losses by the GBP were experienced as European Council leaders publicly dismissed May's plan following the meeting. Citing economic concerns that Chequers "undermined the single market," European Council President Donald Tusk's call for the plan to be reworked brought about an immediate 0.4% drop for the GBP against the USD.
For the GBP, news of a no-deal Brexit proved to be detrimental to positive market sentiment. The potentially negative economic impact and uncertainty surrounding the future of U.K. trade unhinged currency investors. The developments at Salzburg brought the underlying angst surrounding a unilateral U.K. withdrawal from the EU to the forefront of GBP valuations.
More U.K. Resignations, Brexit Summit In Brussels
Upon the October 2018 deadline for a U.K./E.U. withdrawal agreement passing without a formalised deal in place, terms of the pending Brexit transition became a hotly debated issue. Deep fractures from within U.K. leadership began to emerge, as another round of high-level resignations came to fruition during mid-November 2018.
In addition to the governmental turnover, P.M. May's official Brexit proposal drew harsh criticisms from hard-line Brexiteers and Tory party opposition. With negotiators eager to solidify the transition, the Brexit Summit at Brussels scheduled for 23-25 November gained added importance.
The GBP experienced extreme weakness following the sudden resignations of two senior U.K. cabinet members. On 15 November 2018, Brexit Secretary Dominic Raab and Pensions Secretary Esther McVey exited their posts citing differences with May's proposal for the U.K.'s withdrawal.
As stated in a letter of resignation penned by McVey, "We have gone from no deal is better than a bad deal, to any deal is better than no deal." Similar comments were echoed by Raab, publicly stating that he "could not in good conscience" support May's plan. The tone of comments from each resignee gave currency traders and investors reason for concern over the future of the U.K. economy. Also, they alluded to growing opposition to May's leadership from within the Tory party.
The resignations injected fresh political uncertainty to the Brexit transition, prompting a rapid selloff in the GBP. Within an hour of Raab's decision becoming public, the GBP fell 2% against the USD.
Similar action was observed against the euro and Swiss franc for the 15 November 2018 session. Values of the GBP/EUR fell by 1.85%, while the GBP/CHF posted losses of 1.60%. The bearish sentiment toward the GBP following this round of resignations proved more severe than that of the abrupt July 2018 departures of then-Brexit Secretary David Davis and U.K. Foreign Minister Boris Johnson.
The political turmoil in the U.K. was put on hold going into a scheduled U.K./E.U. Brexit Summit for 23-25 November 2018 in Brussels. At the summit, May's plan for Brexit was submitted to the EU council for approval. Following a one-hour discussion, the council formalised support for the withdrawal agreement with all 27 member nations signing on.
In the lead up to Brussels, enhanced volatility once again struck the GBP. Daily trading ranges for the GBP/USD on 22-23 November became extended. Although exchange rates did not trend directionally, session ranges of 150 and 95 pips were observed.
For the same period, the GBP/EUR exhibited similar volatility. Ultimately, the GBP gained more than 80 pips against the EUR over the 48-hour stretch, a signal that forex participants were optimistic toward the U.K. in regards to the outcome of the summit. As in Salzburg two months previous, the summit at Brussels brought fresh Brexit uncertainty and proved to be a primary catalyst for exchange rate volatility facing the pound.
As a general rule, markets are not fond of uncertainty. The 2016 vote in favour of Brexit created high levels of investor angst regarding the GBP, comparable only to the immediate aftermath of WWII or Black Wednesday. Subsequently, the transition process has been a rollercoaster ride for valuations of the pound sterling.
A brief summary of the forex price action facing the GBP amid the key events of the Brexit transition:
|Event||Gain Or Loss Versus The USD|
|Vote For Brexit||-10.0%|
|Article 50: Legal Challenge Upheld||+1.2%|
|Article 50: Parliament Votes "For"||-0.7%|
|Article 50: Invoked||-0.3%|
|Divorce Bill Announced||+0.6%|
|Transition Deal Announced||+0.9%|
While the events listed above certainly influenced the pound sterling's pricing across the forex, the unexpected resignations of U.K. leadership did as well. The departures of Davis and Johnson intensified uncertainty regarding the prospects of a hard or soft Brexit. As a result, the GBP experienced significant short-term volatility as the U.K. dealt with surprise turnover in the Brexit transition team.
The initial shock of the Brexit vote was extreme. GBP valuations plummeted as the future of the U.K. came into question. As time passed and details surrounding the U.K.'s withdrawal were hammered out, many concerns began to fade. In the 18 months following the Brexit vote, the GBP/USD hit 1.4000, a 50% recovery of the Brexit crash. However, performance against the euro remained depressed, as values hovered near post-Brexit bottoms.
The U.K.'s future is a subject of debate among economists. The ability to craft its own trade deals amid a global economic resurgence is frequently cited as a potential driver of prosperity. Conversely, uncertainty pertaining to the fishing industry and possible Scottish independence are looked upon as negative factors that may hinder economic performance. Ultimately, only time will tell whether the U.K.'s economic growth and subsequent BoE policy will drive the value of the GBP higher.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…