Sterling volatility set to increase ahead of Brexit vote

This month’s Brexit vote is likely to be a seminal moment for the UK economy, prompting significant volatility in the pound. Last month the OECD warned of a seismic global dislocation in the event of a UK vote to leave the EU on 23 June.

This month's Brexit vote is likely to be a seminal moment for the UK economy, prompting significant volatility in the pound.

Last month the OECD warned of a seismic global dislocation in the event of a UK vote to leave the EU on 23 June. This probably won’t be the only hyperbolic warning in the lead up to the vote, with the IMF set to add its twopence worth in the wake of the  US Federal Reserve rate meeting on 14-15 June.

Not surprisingly, a lot of the uncertainty and doom-laden predictions have started to weigh down the economic performance of the UK in some of the recent Q2 economic data, reinforcing the truism that if you talk about a potential problem enough it tends to feed into reality. How much of this slowdown is due to uncertainty about the outcome of this month’s vote and how much is down to the general slowdown in the global economy isn’t clear, but the effect on sterling has been quite noticeable in the past few months.

Fresh from coming off a decent performance in May as markets started to get comfortable with the idea that the upcoming vote would produce a vote to remain, some polls then suggested that the leave campaign had edged into the lead. Over the past six months the direction of travel has been clear, with sterling weakening across the board, though we did see evidence of a strong rebound in early April, and throughout May. Some of this rebound has since disappeared but it is noticeable that the bulk of sterling’s declines have come against the yen.

Source: CMC Markets

This isn’t too surprising given that investors tend to push money into the Japanese currency when risk aversion is high or when stock markets are falling. This is because the yen is perceived to be a safe haven, as Japan is one of the world’s largest creditors, or surplus countries.

It is noticeable that the pound has also lost ground against the euro, which is surprising given that a UK vote to leave the EU won’t be a zero-sum game. There will be ripple-out effects with respect to European countries, which could cause significant euro weakness, though it could be argued that any concerns will be mitigated if politicians come together to reassure markets.

It is clear that in the lead-up to the vote volatility in the pound is expected to be high, as the polls edge back and forth. Given the bearish sentiment currently surrounding sterling there is a high probability that a vote to remain could well see the pound ratchet sharply higher on a relief rally as investors roll off their Brexit protection.    

Follow our Chief Market Analyst, Michael Hewson, on Twitter: @mhewson_CMC.



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