Pound Could Fall 12-15% Warns Osborne’s Treasury (Warning: Pinch of Salt Required for Digestion)

George Osborne and exchange rate moves

The UK Treasury has revealed what they believe to be the “immediate economic impact of leaving the EU” which cites a negative shock to both jobs and the pound sterling exchange rate complex.

In excess of 500K jobs could be lost while the British pound index could slip 12-15% lower warns the Treasury, which falls under control of Chancellor George Osborne, a leading Remain advocate.

Sterling depreciated by around 7% from its peak in November 2015 on a trade weighted basis.

The Bank of England has estimated that, by mid-May, “roughly half of that decline reflects perceived risks associated with the referendum on UK membership of the European Union.”

Jobs in the financial sector were cited as being particularly at risk of an exit.

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Two Scenarios: Shock and Severe Shock

There are two scenarios envisioned were the UK to vote to leave the European Union.

In the Shock Scenario:

  • Pound falls 12 pct
  • Unemployment would increase by around 500K
  • Exchange-rate-driven increase in the price of imports would lead to a material increase in prices, with the CPI inflation rate higher by 2.3 percentage points after a year.
  • GDP around 3.6 pct lower than when compared with a vote to remain after two years.
  • House prices down 1o%
  • Wages down 2.8%
  • Borrowing up £24BN
  • Assumes that a vote to leave would generate a rise in uncertainty from current levels, in line with historical experience, to just below the peak of uncertainty experienced during the early 1990s recession
  • Assumes a financial conditions effect similar in scale to 1990s recession.
  • Economy would fall into recession with four quarters of negative growth.

In the Severe Shock Scenario

  • Pound falls 15 pct
  • Unemployment rises 800K
  • CPI inflation would increase by 2.7 percentage points after a year.
  • GDP 6 pct lower after two years
  • House prices down 18%
  • Wages down 4%
  • Borrowing up £39BN
  • Rise in both uncertainty and financial market volatility is around 50% larger than in the shock scenario, but still only half of that seen during the financial crisis in 2008 and 2009.
  • The size of the transition effect is linked to the estimate of leaving the Single Market and defaulting to WTO membership.

Further, the report states:

“There are significant downside risks which imply that the impact could be even larger. First, these scenarios do not allow for so-called ‘tipping points’, such as the crystallisation of financial stability risks. Nor do they incorporate the risk of a ‘sudden stop’ in financial inflows, reflecting concerns about the size of the current account deficit.”

We see no notable to the value of pound sterling in the wake of the report’s release - the public are used to the tenor of such government reports.

"We agree that these sorts of effects might be at play following a Brexit, but we would warn against digesting these sorts of precise quantitative estimates without a hefty pinch of salt. In truth, precisely what would really happen is very uncertain," says Chris Hare, Economist at Investec.

Given these uncertainties, Brexiteers have unsurprisingly pounced on the Treasury analysis as  another part of “Project Fear”, with former cabinet minister and prominent Brexit campaigner Iain Duncan-Smith calling the work “categorically unfair and biased”.

"But, we would note that  the paper has had some heavyweight support from former BoE Deputy Governor Sir Charlie  Bean," says Hare.

When called on by the Treasury to give his seal of approval, Sir Charlie said that the  analysis was “reasonable” and that is used the “best possible” techniques.  

Were there to be a shift in favour of leaving the UK would we expect the pound to suffer any declines.

“Given the uncertainty surrounding the vote cable may see far more volatility than present conditions suggest,” says Boris Schlossberg of BK Asset Management.

Both financial markets and book makers remain confident that the Remain side will prevail.

Financial spread betting firm IG say their clients are still firmly of the opinion that the ‘Remain’ camp will win out, with the chance of such a victory for the status quo currently at 78% on the IG binary.

“It will take more than an attention-grabbing tour of the UK by Boris to make a dent in this figure,” says Chris Beauchamp at IG.

Thursday the 19th saw the highest chance to date of Britain voting to stay in the European Union, with the implied probability of a vote for membership rising to as high as 83 percent.

William Hill odds suggest an implied probability of an 83 pct chance Remain would win.

Betfair odds indicated a 77.5 percent chance of a Remain vote, up from 70 pct the previous week.

"Political punters suddenly seem to have made their minds up that, contrary to the opinion polls, 'Remain' is a rock solid bet," Graham Sharpe, a spokesman for William Hill told Reuters.

The British pound rocketed after an Ipsos MORI poll published on Wednesday the 18th May found 55 pct of those surveyed supported staying in the EU while 37 pct wanted to leave and 8 pct were undecided.

Grabbing market attention was the observation presented by IPSOS that the swing to Remain was largely driven by a switch in opinion amongst Conservative reporters; widely held to be more sceptical of Europe than their left wing counterparts.

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