Pound Slumps Against Euro and Dollar as Poll Confirms Brexit Increasingly Likely

The British pound to euro exchange rate (GBPEUR) has fallen sharply on new polling data that shows the majority of UK citizens desire to leave the European Union.

Brexit hits the British pound on foreign exchange markets

Pound sterling hates uncertainty, and the prospect of the UK leaving the European Union presents enough uncertainty to make 2016 a year of hefty volatility.

The working assumption by markets and currency analysts alike is that the good people of the UK will vote to stay within the European Union. That said, we are hearing of more analysts gripping the reality that the UK may leave.

"We see it being a close vote, similar to that of Scottish independence in 2014, for the UK to remain a member of the EU," says George Buckley at Deutsche Bank.

Indeed, polling data that shows this assumption could be wrong will hurt sterling.

As was the case on the 5th of February.

Polling data from YouGov and The Times shows that a clear majority of UK citizens want to exit the European Union.

The poll found that 45% of those surveyed will vote to leave the EU as opposed to 36% who will vote to stay.

19% don’t know. When they are excluded the polling suggests 56% want to leave and 44% want to stay.

Deutsche Bank's Buckley says the poll should be heavily caveated, however:

"First, it is just one poll conducted soon after the announcement by Mr Tusk. Second, the polls shift far more substantially in favour of remaining in the EU if the PM is supportive of the EU deal and willing to campaign vigorously in favour of remaining in (which it seems he is)."

Nevertheless, the British pound moved lower on the back of the news:

The pound to euro conversion is below the 1.30 threshold at 1.2977.

The pound to dollar conversion is nearly half a percent down on the previous day’s close at 1.4532.

The pound to Australian dollar is softer at 2.0230

The Pound Could Fall by up to 20% say Goldman Sachs

The downside risks to sterling of a British exit from the European Union are substantial argue Goldman Sachs.

In a recent client note on the matter Goldman's George Cole says if the UK voted to leave the EU, the UK’s current account deficit would still be a source of vulnerability despite some recent improvement.

"An abrupt and total interruption to incoming capital flows in response to a ‘Brexit’ could see the GBP decline by as much as 15-20%," says Cole.

Goldman Sachs do reiterate that their 'base case' is for the UK to remain in the European Union.

There does already appear to be a degree of Brexit risk priced into sterling at present, particularly the GBP to USD conversion suggest Goldman Sachs.

Using their standard regression framework, which models currency movements based on interest rate differentials, with controls for risk appetite and oil prices, Goldman Sachs say they can see that the move in the pound/dollar is somewhat consistent with the movements in rates and risk sentiment.

"However, GBP/$ has weakened by more than rate differentials would imply – this ‘unexplained’ residual suggests some emergence of idiosyncratic risk, perhaps related to ‘Brexit’ fears," says Cole.

Gilt Markets Absorbing Brexit Premium

TD Securities have just confirmed to clients that a recommendation to short sterling gilts has been stopped out as the fixed income markets are hit by Brexit turbulence.

"Whilst we continue to expect a correction in UK rates we note that Brexit risks will now continue, in the near-term, to play out more on the futures, making positioning across the strip harder to time," says Renuka Fernandez at TD Securities in London.

Like Goldmans, TD do not see Brexit materialising, but, rates at theses lows do offer attractive risk/ reward for positioning for Brexit materialising.

"With the June’16 contract implying a 3m rate 2bp below the current fixing, suggesting a minimal 2bp loss from the future rolling down but potentially a 25—50bps gain if Brexit materialises," says Fernandez.

What to Watch: The Week Ahead

UK industrial production is due on Wednesday the 10th and is tipped to rise 0.3% mom (+1.4% yoy) in December, and manufacturing output to rise 0.5% mom (-1.0% yoy).

Manufacturing activity remained subdued in December according to the PMI; however, it is nonetheless consistent with a slight pickup in the official manufacturing output measure at the end of the year.

Partially offsetting this, energy production will likely again provide a downward contribution to industrial production due to the unseasonably warm weather.

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