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The effect of a 'no-deal' Brexit on GBP

22 December 2017UKEuropeFX
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  • Despite recent fluctuation due to Brexit, GBP saw robust trading in 2017
  • Two-year transitional period will see continued uncertainty for the currency
  • Looking ahead to phase two of negotiations, GBP is still preferred over USD

Despite stormy waters during initial Brexit discussions, Citi Analysts have found that GBP remained relatively robust over the last 12 months, with foreign exchange seldom trading below 1.30 in the latter half – this is largely due to undervalued purchasing power, along with a bearish US market. They predict that sterling will continue to fluctuate as negotiations continue, but could see uplift in the longer-term depending on trade talk outcomes.

The current EU deal would see the UK effectively remain a member of the EU without the voting rights. Should the Prime Minister ask for any further autonomy, or influence over EU rule-making, Citi Analysts note that the negotiation process could be lengthened, bringing a 'no-deal' Brexit firmly back into the picture.

Citi Outlook on GBP in 2018

Despite these uncertainties, Citi Analysts believe that sterling may hold positive opportunities, even after the currency's historical lows of 2017 are taken into account. Indeed, they forecast GBP to be a more viable choice than directional trading – though the currency will likely remain volatile over the next 12 months. While difficult to ascertain without a political backdrop, their insights have led them to the qualitative forecast below for GBP performance based on the outcome of a 'no-deal' Brexit.

In the case of a soft Brexit

Should a more lenient agreement be made, Citi Analysts take a near-term bearish, longer-term bullish stance on GBP. They expect this kind of outcome would result in a short-term fall in GDP, but should ultimately be beneficial in the long run. It would also likely see a quicker recovery than a hard Brexit.

Citi's research also indicates this kind of deal would likely bode well for the UK moving forward. A relatively open Britain would be an attractive hub for foreign investors, offering a common language, low corporate tax and business-friendly regulations, while inward migration would also help to support the local economy.

In the case of a hard Brexit

In the event of a hard Brexit, Citi Analysts predict some weakness in the short term for GBP, with a less bullish effect expected for the long term. Fuelled by trade restriction and protective tariffs, higher domestic inflation and support from the Monetary Policy Committee could see less short-term depreciation, while local industry could provide the alternative to costly imports, leading to a steadying effect on sterling.

But while the short-term prospects look healthy, a protectionist economy would likely see lower GDP, and thus GBP, if continued over the long term. In the first few years of such a negotiation, higher import tariffs and stricter regulation matched with lower productivity and immigration would lead to higher inflation, and likely lead to the erosion of UK competitiveness.

In the case of a last-minute Brexit

Should negotiations fall through at the last minute, Citi Analysts predict that a combination of the above market reactions, including a possible short-term hit to the economy, would be further accentuated. A shock to the market would see a sharp rise in volatility across all UK financial sectors, likely bringing a deeper short-term economic downturn.

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