The British pound has fallen back from its best levels against the euro and dollar since May - but where will the pound trade following the release of results on Thursday night?
- The pound to euro exchange rate is today at 1.2990
- The euro to pound exchange rate is today at 0.7699
- The pound to dollar exchange rate is today at 1.4645
We get the sense that the pound has witnessed its best levels ahead of the referendum outcome, which is likely to be made known at around 4AM on Friday the 24th.
However, analysts believe that the release of privately conducted exit polls at around 10PM on Thursday evening could really set sterling in motion, so with big moves being promised, it is likely GBP will consolidate over coming hours.
Also keep in mind that various constituencies are already pegged out as being pro-Leave and pro-Remain. Therefore, watching the outcomes in these areas could also provide some hefty moves for the pound.
That said, low liquidity conditions could see the currency bucked about a bit, but directionality is only likely to be found on results night.
Note that while polling data is split evenly, bookmakers are ascribing a 73% chance the UK votes to Remain in Europe.
Our base-case at this stage is sterling will ultimately move higher.
The problem we have is trying to ascertain just how high it can go.
We are poring over the research that sits on our desk in order to try and gauge how far the limits to any post-referendum move would be.
Brexit Result Targets and Ranges for the Pound
Firstly, with regards to a Brexit result, there is a common agreement that the initial reaction would be one of steep declines.
I note not many analysts are too fussed when it comes to calling any specific targets; perhaps this betrays an inherent bias that such an outcome will be unlikely?
Or, it could reflect that calling the bottom is simply too difficult and ultimately futile.
Incidentally, the size of the potential decline only keeps growing if we consider just how sterling is move at present; the higher it goes, the further the fall.
“A pro-Brexit outcome would cause the correction to deepen, with an initial downside of between GBP/USD 1.38 and 1.35,” says Asmara Jamaleh, an analyst with Intesa Sanpaolo in Milan, Italy.
Jamaleh cites the 1.35 mark is an important threshold, as it was the low hit in January 2009, below which the exchange rate only dropped as far back as in 1985.
Downside against the euro may be a little more contained though - understandable if we consider the euro has arguably more to lose from a Brexit with Citi forecasting an initial 5% decline in the headline EUR/USD rate on an exit.
Nick Parsons at NAB suggests sterling could surge to above 1.44 within days of a Brexit. That would really throw the cat amongst the pigeons.
While Intesa Sanpaolo’s Jamaleh doesn’t see such a bounce, he is however looking for a more ‘moderate’ decline towards the low end of the 1.250-1.1765 range.
“Against a background of widespread pre-referendum market tension, the single currency’s negative reactivity is explained by the risk of an increase of independentist forces within the euro area in case of Brexit, and by the difficulty of estimating the potential negative fallout on the euro area economy,” says Jamaleh, explaining why the euro could suffer.
While the analysts mentioned don’t see the lows witnessed following the 2008 financial crisis, there are others who see the EUR/GBP potentially moving to parity over by the time 2017 begins.
Under a range of outcomes extrapolated by UBS, the risk is that a vote to leave the EU, or the expectation thereof, could force the UK current account deficit into quick rebalancing mode.
“The currency could bear the brunt of the adjustment if markets focus even more on the imbalance. A range of outcomes is possible, but one risk is that GBP could then depreciate by a cumulative 30% on a trade-weighted basis,” says a note from UBS on the matter.
Bremain Targets for the British Pound
If the “Remain” campaign prevails, the pound’s immediate reaction should be to make further gains.
Jamaleh is targeting the GBP/USD exchange rate towards 1.50; this number is certainly the most common forecast given by analysts.
Against the euro, GBP should make a stab at 1.33.
We can also hazard a pretty good guess ourselves by observing where the limits to the range in GBP pairs will lie by observing implied volatility on the options markets.
These are the exchange rates being insured against by thousands of traders.
Implied volatility essentially betrays a market that is unsure of where exactly the pound will trade at a given time in the future - the higher the implied volatility the greater the range within which the pound is forecast to trade within.
“Readings from the option market prices a 72% chance of GBP/USD trading anywhere between 1.32 and 1.51 on the afternoon of June 24th,” says Chris Turner, analyst with ING in London.
Analyst Ipek Ozkardeskaya at London Capital Group has read the same markets a little differently and says the pound could be biased even higher on a Remain vote:
“Option markets have also been shaky this morning, with a sharp decline in put options maturing in three months versus call options.
“According to the pricing in the spot pound market, a Brexit event could drag the GBPUSD down to 1.30. It is certainly a risk worth being hedged. On the flip side, buyers are ready to depart for a relief rally if Britain decides to remain in the EU. We do not rule out the possibility of a post-referendum bounce to 1.50/1.55 area.”
Longer-Term Gains Forecast on Remain Win
Looking beyond the referendum, and based on an assumption Remain will win, there is a definite sense that sterling is undervalued at current levels and should recovery ground and head back to fair value.
This is justified if we consider the UK economy has performed beyond expectation when the potential pitfalls of the EU referendum are considered.
This month we have seen wages beat expectations, while official manufacturing data shows the weaker pound is starting to have a positive impact on manufacturing.
In essence, the UK economy is one that is inviting an interest rate rise at the Bank of England.
There is a sense that the Bank will oblige and deliver such a move once the referendum has passed.
If this is the case, then expect sterling to trade with an upside bias for the remaining months of 2016.
“Should Remain come out on top, the prospect would stay in place of a BoE rate hike cycle starting around the beginning of next year, with resulting expectations for an appreciation of sterling both against the dollar,” says Intesa Sanpaolo’s Jamaleh.
Intesa are forecasting GBP/USD towards 1.50-1.55 in the run up to the first rate rise.
Consensus forecasts are less optimistic though with polls showing most analysts are forecasting GBP/USD at 1.44 by the turn of the year.
The pound to euro exchange rate is meanwhile seen towards the 1.33-1.35 range by Intesa.
The forecast target for 1.35 echoes that made by fellow banks Lloyds, Danske and Nordea who are expecting the pound to trade towards 1.35 towards the start of 2017.
Consensus estimates place the GBP/EUR closer to 1.30.
Strategy: Pound to hit 1.50 and then Fall say Morgan Stanley
Not everyone is convinced that sterling will be able to hold any post-EUref gains.
Morgan Stanley have in fact told clients that selling sterling towards 1.50 is likely to be an advantageous strategy:
"GBPUSD should remain bid for now, with a chance of testing levels around 1.50.
"However, this pre-vote rally would provide a selling opportunity with a target of 1.35 reached under the condition of Britain staying with the EU, but struggling to consolidate its balance sheets.
"Leaving swings in political uncertainties aside, sterling has become increasingly dependent on commodity price swings and the evolution of global risk appetite."
However, now is not the time to chase the pound to dollar exchange rate to 1.50 argues analyst Jeremy Stretch at CIBC Markets:
“Despite that improving confidence we would be wary of buying GBP/USD towards recent highs as the risk reward into the poll appears inappropriate.”
Note that polling agency Survation have released their latest poll ahead of the EU referendum.
The poll, conducted for IG, showed that Remain has edged ahead and commands 45% of the vote, a shave above Leave's 44%.
“If the trend towards remain continues that would support the Cable rally, but any reversal would suggest GBP/USD looks increasingly overbought at current levels,” says Stretch.
Despite the results, sterling has managed to extend its advance against the euro while falling back slightly against the dollar.
Traders appear content to call the referendum a done deal.