Is the UK exchange rate failing to reflect the risk of a disorderly Brexit?

Sterling is giving a poke in the eye to the Efficient Market Hypothesis. With the exchange rate neglecting to swallow the prospect of the UK hurtling out of the EU without a deal. Such a result cannot be ruled out. If anything, the risk is accelerating, considering the latest twists in British politics. A no-deal exit is a “central scenario”, in the words of the French foreign minister, and few outside of the hardcore “Brextreemists” believe it would leave the UK economy unscathed. And yet the pound has scarcely changed, still held around $1.32 to the US dollar. This reveals two phenomena: investors’ rather touching faith that British politicians will yet preserve the national interest, and a fall in the US currency. It is hard, if not insurmountable, to find a single fund manager who thinks a no-deal Brexit will pass, which is why it is not being factored into the pounds exchange rate already. Such certainty has encouraged sellers to reel in their bets and encouraged the pound to become one of the best-performing currencies in the world against the dollar so far this year.

Some of the strength in the sterling-dollar exchange rate, however, is a mirage. Yes, the pound was impassive when parliament’s Speaker undertook to rule out a repeat vote for MPs on the prime minister’s favoured Brexit deal. And Sterling was unyielding when Theresa May on Wednesday insisted on remaining with her chosen course. But a glimpse at short-term fluctuations in other principal currencies indicates that the pound has been upheld by the vulnerability in the dollar. The euro shot higher against the US currency on Wednesday after the Federal Reserve backed even further aside from raising interest rates.

The yen gained and emerging-market currencies headed off to the races. Yet Sterling almost stood still, a triumph, considering the farcical state of the nation’s politics. Yet it still dropped against the euro, and it is obviously lagging behind other currency rivals. But the swoon lower in the dollar is at least affording a meager encouragement. Be under no delusion, however: that protection would almost surely prove inadequate if politicians were to disappoint investors still hoping for an outbreak of common sense.