The UK parliament has devoted most of the last few weeks in a state of anarchy, with pressing questions about the fate of the state turning on desperately close votes in the House of Commons. By comparison, across town in the City of London and Canary Wharf, where the world’s foreign exchange market is centred, there has been a sense of mysterious calm over the fate of the pound. Immediately after the Brexit referendum in 2016, sterling dropped by about 10 percent. In recent weeks, though, despite the original March 29 deadline for withdrawing from the EU, the pound has jumped around in response to political news but in a limited range, about $1.31 against the US dollar. However, that restricted movement indicates a precarious balance between the contingencies of disparate outcomes, including leaving without a deal, leaving with one shortly, or postponing the resolution until next year.
Analysts and investors have been looking at the odds at bookmakers. By noticing the relationship of fluctuations in betting probabilities to shifts in the pound, they have estimated what the prospects for sterling are expected to be. With bookmakers making an odds on of an over 50 percent chance the UK will still be in the EU by the end of 2019 because it has chosen to remain or been permitted a lengthy extension. But the estimated chance of a no-deal Brexit, although it has diminished in recent weeks, has nevertheless been around 25 percentin the past couple of days.
As and when outcomes are ruled out, there is a potential for a significant movement in the currency. If the UK crashes out of the EU without a deal, the recent relationship between sterling and betting odds suggests that the pound will crash to below $1.15, its lowest level for over 30 years. Those probabilities themselves may be crudely assessed. Bookmakers’ odds are hardly infallible predictors: they got the referendum in 2016 badly mistaken.
Last week Luis de Guindos, the ECB’s vice-president, cautioned that markets seemed to be underpricing the risk of no deal. Faced with such confusion, there is little that policymakers, as well as investors, can do except to stand poised to act rapidly if a hard Brexit threatens economic and financial stability. Mark Carney, the governor of the Bank of England, although he has wisely refused to commit to exact probabilities of a no-deal Brexit or hard estimates of what will occur if one takes place, said this week that the chance of an unplanned exit was “alarmingly high” and denounced the notion that the UK and EU ports and customs procedures would cope if it materialised. Long-term investors, struggling to peer through an impenetrable thicket of confusion towards the UK’s future, are wise to focus on insuring themselves against risks rather than taking big bets either way. A no-deal Brexit, particularly if the two sides do not quickly return to the table and agree a managed withdrawal, could inflict serious damage on the UK economy. Wild swings in sterling will merely be a precursor of that. The calm surrounding sterling in the foreign exchange markets reflects a temporary balance between competing outcomes rather than long-term stability.