Brexit: British pound optimism a bit premature?

Brexit has been a humbling affair for many Brits; so too their beloved currency, the pound. Having fallen 15 percent against the euro since the June 2016 referendum, is it too soon for sterling to stage a comeback?

The frenetic world of currency trading has little in common with the tranquil lifestyle savored by many British expatriate pensioners, seeing out their last years in the warm Spanish winter. The silver sun worshippers and dealers of the world's most-swapped currencies do, however, share a common distraction; they both remain gripped by the ongoing parliamentary tussle over Brexit.

The British pound — the world's fourth most traded currency — has been in the doldrums since Britain voted in June 2016 to renounce its membership of the European Union. Sterling, as it is also known, plummeted between 15 and 20 percent against the world's other G10 currencies in the wake of the referendum result, causing living standards for many Britons to fall as a result of rising inflation from the higher price of imports. The pain was felt at a time when wages were still stagnant in the wake of the 2007/8 financial crisis.

Read more: Pro-Brexit campaigner James Dyson to move HQ to Singapore

British expats, who receive their pensions in pounds but spend them in euros, fared even worse; the large drop in income forced tens of thousands of them to consider packing up and returning home. 

Fresh buying signal?

Those that remain on Spain's Costas have, however, been buoyed by recent forecasts by Deutsche Bank and Goldman Sachs that sterling may have hit rock bottom; and in 2019, may be one of the world's best-performing currencies.

The British pound, the world's fourth most traded currency, plummeted in the wake of the Brexit vote

"It's time to buy the pound," said Deutsche Bank's analysts, on January 15, immediately after British Prime Minister Theresa May lost a vote on her government's EU withdrawal agreement. This sudden positive sentiment led many global investors, who have been bearish about the British currency and the economy for almost three years, to see both in a new light.

"The pound's potential to rally stems from the perception that the risk of a hard Brexit [where Britain leaves the EU and trades with the bloc under World Trade Organization rules] will be taken off the table," Jane Foley, head of FX Strategy at Dutch lender Rabobank, told DW. "This is possible, though it is not yet guaranteed."

Read more: The draft Brexit deal — what you need to know

Confidence has emerged from an increased likelihood that lawmakers will delay Brexit or that a second referendum could mean Britain will remain in the EU after all, although the odds of all the possible outcomes keep changing day by day. The renewed interest in the pound has already seen it rise 2.1 percent against the euro and 1.2 percent versus the dollar so far this year.

"If a softer Brexit does come to fruition, GBP/USD is likely to rally sharply towards 1.36 [from 1.28 in mid-January] and steadily on to the 1.40s. This time around though, gains should be sustained, especially if the Bank of England raises interest rates," said George Vessey, UK currency strategist at Western Union Business Solutions in London.

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If Britain was, however, to crash out of the EU without a deal on March 29, Vessey cautioned, the pound "could lose up to another 15-20 percent from its current value."

Pound rebound in sight?

The London-based economic research consultancy Capital Economics also believes that sterling's potential to strengthen has been "underestimated." "Once the Brexit fog clears ... we suspect the pound will rise to $1.45 by the end of next year," said Paul Dales, the group's chief UK economist, adding that the currency's fair value is about $1.50.

Read more: UK PM Theresa May to take Brexit options back to EU negotiators

The next question is whether any sterling rally will last. Even if Britain's Parliament does approve Prime Minister Theresa May's withdrawal agreement in some form, the British economy still faces several years of uncertainty as London and Brussels negotiate a post-Brexit trading partnership. "If trade talks don't go to plan, then the pound's strength could wane," Vessey told DW, adding that the UK's success at striking new global trade deals will also be critical.

Although Brexit is often blamed for the pound's woes, the financial crisis had a far worse impact on the British currency. In 2007, the pound hit as high as 2.11 against the dollar and 1.53 versus the euro, before plummeting to a low as 1.39 and 1.03 respectively.

Around $325 million in British pounds change hands each day, according to the Bank for International Settlements

In the lead-up to the banking crisis, the City of London was the world's largest financial hub — bigger than New York, partly as a result of regulation introduced following 9/11. Such massive inward money flows during boom times were positive for the pound. But, because the British economy is so reliant on its financial sector, it was hit "hard and fast" when the tide turned, Duncan Connors, assistant professor at Durham University's Business School, told DW.

Wishful thinking?

Unlike the currency markets, Connors thinks the pound could relive the heady days of the early 2000s, even in the event of Britain crashing out of the EU. "If there is a hard Brexit followed by a series of very liberal and open free trade agreements, then you may find that the UK becomes an asset economy again."

Read more: India, the EU and the hard realities of a post-Brexit world

London could then see a return of the affluent classes from China, India, Russia, and the Middle East to buy houses, build office towers and invest in infrastructure, Connors predicted, even if Britain's financial sector loses some of its shine to Frankfurt and elsewhere. "In that case, the pound will appreciate massively," he told DW.

Currency traders are optimistic, in the short term, that they could see huge profits from the pound's reversal of fortunes. British retirees in Spain, on the other hand, may have to wait several more years until their monthly pensions, in euro terms, grow back to the 30 percent premium they once enjoyed.