All eyes on the prize as pound takes centre stage
On Thursday, June 23, Britain will vote on whether to remain part of the European Union. This historic plebiscite is perhaps the most important for the UK in decades. A recent series of polls indicates that the ‘remain’ camp is gaining momentum over those wishing to leave the European Union. However, currency traders remain deeply concerned about the impact of the upcoming Brexit referendum on the GBP, and the costs associated with insuring businesses in this highly volatile environment. The general rule as it pertains to the GBP vis-à-vis the Brexit, is as follows: any indications that Britain is leaning towards an exit from the EU will drive up volatility with the GBP and bring about a depreciation of the sterling.
The upcoming referendum has resulted in growing concern about the stability of the GBP in the lead up to the historic vote. Increased levels of trading activity on the sterling options markets have resulted, and currency traders are cautiously eyeing Brexit polls for indications about which way the vote is likely to go. The most recent polls indicate that the ‘remain’ camp is opening up a healthy lead over those wanting to leave the European Union. On Saturday, May 21, a poll was published by Opinium under contract to the Observer newspaper. This was the sixth of seven polls indicating that Britons wish to remain part of the UK. This latest poll placed a ‘remain’ percentage of 44% versus those who wish to break from the European Union at 40%. It is interesting that the ‘remain’ camp has increased its lead by 2% from the same poll conducted at the end of April.
Various bookmakers and spread betting companies across the U.K. have also seen tremendous levels of activity with the upcoming Brexit vote. As it stands, the wagers are firmly in favour of Britain remaining part of the European Union. For example, Ladbrokes and William Hill has Britain remaining in the EU with odds of 1:6. This means that for every GBP 6 wagered, hunters will receive 1 pound in profit. Simply put, this indicates that the overwhelming majority of wagers placed at spread betting sites favour the UK remaining part of the Union. Spread betting sites are presenting currency traders and financial analysts with an alternative to Brexit polls being conducted by major newspapers and government bodies. In fact, many financial analysts trust the spread betting percentages more than the pollsters. One of the major changes that has taken place with Brexit polling is that conservative voters have swung from wanting to break with the EU to remain as part of the EU. Another important factor for Britain’s membership of the EU came in the form of the G7 industrial nations that unanimously adopted the stance that they want Britain to remain part of the European Union.
One of the most important measures of the GBP is implied volatility. This measure gauges market sentiment as it pertains to the GBP and its movements in the lead up to the Brexit referendum on June 23. Interestingly enough, the implied volatility of the GBP has increased for the three months leading up to the referendum. By March 23, the 3month implied volatility increased to 14.93% from just 11.08% on March 21. If we take into account the 2-month volatility, that increased from 10.98% on April 22 to 13.88% on April 26. Implied volatility is one of the most important gauges of sentiment and currency strength and analysts take it seriously. Naturally the most significant changes will be seen in the sharp uptick, or reduction of implied volatility in the 1-month lead up to the Brexit vote. Implied volatility is less affected by opinion polls then it is by movements in the exchange rate vis-à-vis the British pound. Various highranking portfolio managers now assume that the likelihood of a Brexit has decreased to just 20%. Implied volatility, if it decreases, will naturally be good news for the GBP and caused the pound to rally. rate against its most important partners: GBP/USD at 1.4509, GBP/AUD at 2.0103, GBP/EUR at 1.2930, GBP/JPY at 159.8021 and GBP/CAD at 1.9023.
In all instances, the value of the sterling has risen sharply against its currency trading partner because of the sentiment expressed in opinion polls and at bookmakers. The big thing about a Brexit vote is the uncertainty it creates.
Most the uncertainty will manifest in the way investors react to it on stock markets, with capital investments in the UK and with household purchases in the UK.
If there is a great degree of uncertainty about which way the vote will go, households will generally defer big-ticket investments in property, purchases of assets like vehicles and extravagant spending.
On the corporate side, we are likely to see a reduction in capital investments, perhaps even a deferment until after things have calmed down.
Equity markets in the UK are likely to react in much the same way, with reduced levels of investments as long as sentiment remains shaky. Anxiety is persona non grata when it comes to equities markets and a risk-off approach tends to be adopted.
If we stick with the poll numbers alone, then it looks certain that the risks inherent in a Brexit outweigh the benefits promised by it. But more importantly if the UK votes for a Brexit, London will lose its exclusive status as the centre for all euro financial transactions. And that is something that the UK can ill afford, and Britons too will fight hard to prevent that from happening.