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The Pound May Strengthen After Brexit

The world is about to enter a new era of national sovereignty.  As a potential trendsetter for other local control advocates, the United Kingdom may soon tell the European Union that they no longer want their regulatory control apparatus - the UK wants freedom over regulation.  This black swan event is historic by most any measure.  Brexit, though, comes with cautious excitement, as well as some considerable concern about the risks.

Brexit has so many dimensions to it that it’s impossible to mention them all here.  One measure of the success or failure of Brexit may be how the Pound performance in the foreign exchange market.  The question asked here is simple – Could the Pound actually gain value once Brexit has actually happened?

Could the Pound actually gain value once Brexit has actually happened?
Outside observers, and perhaps most foreign exchange traders (certainly most academic analysts), seem to view the idea of the Pound gaining value once Brexit is actually finished as goofy on the surface.  They may simply say to go look at what the Pound has done since the Brexit Referendum.
Figure 1 presents such a view.  The figure captures the performance of the Pound against the US Dollar in the top pane.  The bottom pane is the Pound against the Euro.  

Two colors are shown.  The gray is the pre-Referendum period.  The red is after the Referendum.

Figure 1 is shown in terms of the other exchange currency per GBP (Great Britain Pound).  When the values go up, this means that the GBP is losing value relative to the Dollar or the Euro.  For example, the Euro/GBP ratio in recent years has gone from 0.75 to 0.85.  The rise from 0.75 to 0.85 means that it takes 0.85 Pound to purchase one Euro.  It used to only take 0.75.  Thus, in this example, the Pound has lost value.  

Looking closely at the performance of the Pound before the Referendum and after the Referendum, the Pound lost a good chunk of value right after the Brexit Referendum.  

Interestingly, the Pound’s drop in value did not continue.  For example, the Pound’s value relative to the US Dollar strengthened in 2017, the first year of the new Trump’s Administration in the US.

Looking at the Figures on a Percentage Basis
Let’s take a look at how the Pound performed relative to the Dollar and Euro on a percentage change basis since the Referendum.  This is depicted in Figure 2.

Figure 2: Change in Dollar/GBP and Euro/GBP Since Brexit

Figure 2 has the y-axis inverted.  This means that a decline in either the brown or yellow lines is a drop in value for the Pound relative to the other currencies.

Interestingly, at one point both the Dollar and the Euro were up over 20% compared to the Pound.  That gain has since reversed itself.  As of writing, since Brexit both the Dollar and the Euro are up about 12% against the Pound.

Could the Pound Actually Rise Once Brexit is Finally Finished?
The background of the Pound’s performance against the Dollar and Euro is now established.  Let’s think for a minute on whether the Pound could actually rise once Brexit is finally finished.

The answer, interestingly, could very well be yes.  Since the Brexit vote, the UK economy has actually performed much better than almost any prognosticating economist predicted.

The 12% drop in the value of the Pound may have had something to do with this.  But, perhaps a large portion of the 12% drop may have been due simply to fear.  

When the fear fades into acceptance that the UK will be fine post-Brexit, holders of the Pound may well be delighted with their return.  

This response, though, mostly depends on how much of the 12% drop is due to fear and how much is due to all other sources.  

With the UK economy doing just as well or better than most other EU-based economies, it’s fairly easy to see that most of the 12% drop is probably due to fear, and elimination of the fear could turn into large returns for the holders willing to think differently.