Hard Brexit may lead to $166B bond selloff: BoA

LONDON • Central banks and sovereign wealth funds are likely to dump up to 100 billion pounds ($166 billion) of U.K. bonds and precipitate a balance-of-payments crisis if Brexit talks break down in acrimony, Bank of America has warned clients.

The U.S. bank said selling on this scale would send sterling cascading down to lows not seen since the mid1980s, with a risk of cliffedge falls if the exchange rate breaks below US$1.10.

Kamal Sharma, the bank’s currency strategist, said Britain is dependent on constant inflows of capital to plug the current-account deficit, still 3.9 per cent of GDP despite improvement over the last two years.

Sharma says that even a moderate shift in portfolio strategy would be enough to trigger a “protracted currentaccount crisis” in Britain.

There was a short burst of such selling after the referendum in June 2016. Bank of America data show central banks quickly carried out the biggest liquidation of sterling assets since their data series began. Buying quickly recovered.

Central banks and sovereign funds hold 388 billion pounds ($645 billion) of U.K. debt. The sterling weighting of their reserves is 4.7 per cent, well above the 3.6-percent average over the last 20 years. A no-deal scenario could see this revert to mean abruptly.

“If central banks start to question the role of sterling as a reserve currency there will be serious consequences. We could see the pound dropping to US$1.05,” said David Owen of Jefferies International, a U.S. investment bank.

Neither Bank of America nor Jefferies think a no-deal outcome is likely.

Stephen Jen, a currency expert at Eurizon SLJ, said reserve managers in Asia and other parts of the world would be just as likely to dump the euro if there is a showdown between the EU and Britain.

“Brussels needs to think very carefully about trying to punish the U.K. It is effectively using the threat of trade sanctions as a weapon. But the extreme disruption for the EU itself if this happens would be greater than some might think,” he said.

Bernard Connolly, the European Commission’s former currency director and founder of Connolly Associates, said a weaker pound has already led to a big improvement in the U.K.’s current account — when adjusted for the jobs boom and full employment, the metric that matters.

“Markets have fits of irrationality but they are not stupid. They would quickly come to the conclusion that the pound has become more attractive,” he said.

“Everybody is primed to think sterling will fall if there is no deal, just as everyone was programmed to think that the stock markets would crash if Donald Trump was elected. Well, they did for about 12 hours, and we know what happened after that,” he said.