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The Rise and Fall of a Major Currency

A recent piece in the Financial Times this week reveals the declining role of the British Pound and how it looks more like an emerging market’s currency. It argues that the decline in the pound’s role in the international financial system reflects the small and shrinking UK economy.

This is nothing new, however it reflects yet another episode in the steady decline of the Pound’s influence and role on the global stage. Global Britain after Brexit will have a currency with a smaller influence on the global stage.

Challenges Ahead for the British Pound

In the nineteenth century, the Pound was the currency every investor wanted. The Pound’s stability was the basis of British wealth, and its steady decline reflects the shrinking of British economic influence on the global stage.

Once the mighty reserve currency, it ended up having a regional role recently. Not long ago, it was one of the most heavily trading currencies, together with the Euro, the US Dollar, or the Japanese Yen. Not anymore.

Implied volatility had fallen continuously for the Pound since the 2016 Brexit vote. It makes it resemble much smaller markets and shows how the City of London’s influence faded in the years following the 2016 referendum.

The explanation for investors avoiding the Pound comes from the uncertainty regarding future UK-EU relations. This is Europe, after all, and the two economic blocks (EU’s single market and the British market) must find a way to coexist and, more importantly, to trade. Trade opens up economies and comes with a list of benefits that outpace by far its costs.

On a no-deal Brexit, the risk is that the Pound further losses its sphere of influence. It may fall to parity against the Euro and to 1.10 or lower against the US Dollar.

Investors have a deadline in front – December 2020. If no permanent Free Trade Area (FTA) is agreed by December 31, 2020, the risk of a no-deal becomes a reality. The closer we get closer to this deadline without a major breakthrough in negotiations, the more likely investors’ appetite for once the world’s reserve currency, will decline.

2020 so far, has seen stable rates for the Pound. Long consolidations are viewed even in some markets that traditionally had much higher volatility (e.g., GBPCHF).

Until Brexit becomes a reality, investors should expect similar conditions.

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