Pound approaching ‘pain threshold’

LONDON: The turbulence in the British pound is increasingly resembling gyrations typically seen in emerging markets.

The UK currency shed 4% in July to record its biggest monthly slump since October 2016 amid growing chances of a no-deal Brexit. As well, its 90-day correlation with a gauge of developingnation currencies has risen to the most in almost three years.

Given the US dollar’s continued strength and the shared vulnerability to political risks of the UK and developing nations, this relationship may get more attention in the weeks to come.

And it’s getting worse: the pound now trades at a record low relative to emerging markets. It is underperforming the MSCI EM currency gauge for a third straight month as Prime Minister Boris Johnson signals his determination to take Britain out of the European Union on Oct 31, with or without a negotiated settlement.

The potential for disruption to business and capital flows sparked a 2.7% sell-off in the pound last week. Rapid losses sent sterling-dollar volatility to levels higher than those of emergingmarket currencies such as the Mexican and Colombian pesos and the Brazilian real.

For those who doggedly see the positive side of everything, however, the pound’s weakening may put Britain at a competitive advantage with emerging markets. While the EU accounts for 49% of the UK’s exports, the developing world buys a little over 22%.

The pound’s plunge has done little to sway Mr Johnson so far from his tough line on Brexit. It may be just a matter of time.

A fall of 10% in sterling in a short span may cause the cabinet to back off a no-deal exit, according to Commerzbank. A decline below $1.19 (from $1.212 now) would leave markets in “uncharted waters”, said Manulife Asset Management.

“Increasing market turmoil could put the government under pressure to refrain from a no-deal Brexit,” said Thu Lan Nguyen, a currency strategist at Commerzbank. “As a pain threshold, I could imagine a depreciation just above 10% in a short time that takes the currency close to parity against the euro.”

Still, some analysts say it’s a bit too early for the tremors in the pound to be upsetting the political calculations.

“The government has a pain threshold, but we’re not there yet,” said Ned Rumpeltin, head of currency strategy at TorontoDominion Bank. “It ... may be more a function of the speed with which the pound may collapse that attracts their attention.”