Posted on Oct 26, 2020
The December deadline for the Brexit transition period is quickly approaching. The UK is still holding out on terms of having access to the single market, but without any of the EU regulation compliance.
It’s difficult to see a deal coming to fruition unless the UK compromises. Very recently however, the UK appears to be holding out and reaching a stalemate.
It’s possible we will see compromises in certain sectors, where there is an agreement to follow EU regulation for a finite amount of time. For other sectors, there may be transition periods so the impact isn’t sudden. Given that this is happening during a pandemic, it would be catastrophic for a no deal to happen — though, this certainly looks like the current outcome.
A no deal would greatly affect the £225bn business services industry. A deal is also likely to negatively impact the industry too, just not to the same extent. Currency is expected to be hit, which explains the rising demand for Currency Forward Pound - Euro hedging. There’s also 700,000 fewer employed since the start of the coronavirus pandemic - a huge number, considering the labour force total is 34m.
Impact on sterling
The fallout from deal or no deal will both have significant impacts on the Great British Pound Sterling. The difference between a deal or no deal could be around 15% in value. The current GBP price is factoring in the risk of a no deal, so a deal would undo this and appreciate accordingly. However, an even bigger swing could take place in the event of a deal, as the current price is only partially factoring in a no deal, given it isn’t yet a certainty.
The FTSE and the GBP have a slightly negative correlation, meaning that the cheaper pound usually attracts FTSE investment, meanwhile companies aren’t hurt too much because over three quarters of revenue comes from abroad anyway. However, it’s not a statistically significant relationship, and with novel current times, it’s extremely difficult to predict the FTSE regarding the Brexit outcomes. It’s likely that a no deal Brexit, which hurt the pound, will also hurt the FTSE due to an interruption to free trade and a struggling economy.
In the past decade, the relationship has been utterly unpredictable. Whilst the FTSE impact would be fragile and unpredictable, the sterling one is slightly easier to forecast. In the event of not reaching a deal, it’s near certain that the sterling will fall. This was seen the moment that Brexit was announced in the 2016 referendum results. The pound immediately collapsed. The idea of no free trade and an economic crash is just not appealing to foreign investors - the UK needs European markets, at least in the short term.
Everytime there is no-deal related news regarding Brexit, the pound takes a hit. It’s become quicker to keep up with Brexit developments simply by tracking the sterling price. Of course, the EU will also suffer greatly from a no-deal, and thus the Euro may fall against the USD too.
Pound-Euro parity - is it likely?
Whilst the pound strengthened over the Euro during the end of summer/early autumn, the pound soon collapsed. It’s currently 1.10 EUR, up from 1.09 a month ago. The price is likely to be incredibly unstable over the next couple of months there will be many headlines, speculations and political arguments between Britain and Brussels.
A pound-euro parity was speculated to be at high risk back in Easter. Today, it seems just as possible. A pound-euro parity will not occur anytime before anything concrete has been established over our future. The reason for this is that a no-deal possibility is already factored into the current price, which stands 10c away from parity.
However, given the aforementioned predictions regarding a 10% swing if a no-deal Brexit occurs, that leaves us very much with a 1:1 pound-euro. So, the likelihood of this happening is dependent on the likelihood of a cold, hard no-deal Brexit. Any compromises, deals or further delays that are made are likely to go in favour of the pound staying above the euro.
How to defend yourself from the impending pound-euro swings
As we’ve established, the pound-euro pairing is going to be rather chaotic - more so than it already is. This is out of our control, but what is in our control is mitigating our exposure to currency risk.
The most effective way to nullify the scenario of a fast and/or vast depreciation in your currency is through hedging. In particular, currency forwards for the Euro. This will enable you to lock in a pre-agreed rate (which isn’t far off today’s price), which will then be executed in a pre-agreed date in the future. For example, a few months from now, pound owners could be contracted to purchase X amount of Euros on a certain day in January.
This is profoundly useful for those who have to deal with a certain exchange in the future - i.e. a small business that buys inventory from Europe every month. However, it’s not only businesses that can make use of hedging - it’s become increasingly accessible for freelancers, expats and everyday people to purchase small contracts.
The peace of mind is huge, knowing that you have already locked in a price. Of course, if a fantastic deal strikes between Britain and the EU, the pound owners who bought forward contracts will lose out on the strengthening pound. However, this is an insurance likely worth buying when the risks are potentially larger than the rewards.
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