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Euro and pound jittery ahead of referendum

June 22, 2016

The euro and pound have fallen as the Brexit referendum approaches in the UK. With the "remain" and "leave" camps running almost level in the polls, the markets are reflecting the uncertainty, as wary voices grow.

Großbritannien 5-Pfund-Banknote mit Winston Churchill
Image: Reuters/J. Giddens

The euro was down 0.5 percent against the dollar to $1.1259, while the British pound - the main vehicle used by investors to express their views on the UK's referendum on EU membership on Thursday - weakened on Tuesday by 0.3 percent to $1.4675.

While the pound remained above the $1.41 level it had been at a week ago when fears a "leave" vote would win this week's referendum grew, the UK currency, like the euro, gold, shares globally - and the yen - have seen synchronized swings as the prospects of "Brexit" fluctuated in recent weeks.

Modest moves in UK government bonds, which also partially reflect confidence in a country's ability to sustain its future financing needs, indicate a belief that the pound's fall would likely be pronounced but not catastrophic.

Warnings from near and far

"There will be significant economic repercussions if Britain breaks with the 28-member European Union," US Federal Reserve Chair Janet Yellen said on Tuesday.

If the UK - the world's fifth-largest economy - leaves the EU, the impact on financial markets could become a major obstacle for the global economy, the central banker continued.

Meanwhile, European Central Bank chief Mario Draghi said the ECB was preparing for "all possible contingencies."

"It's difficult to speculate about one outcome instead of another," Draghi said in a speech at the European Parliament, adding that the referendum was adding uncertainty to markets.

Black Friday again?

Top investor George Soros, writing in the Guardian newspaper, said Britain leaving the EU would trigger a bigger and more damaging fall for sterling than the so-called "Black Friday" in 1992, when the UK dropped out of the EU's Exchange Rate Mechanism, or ERM, an early precursor to the single currency.

Ungarn George Soros 2010
George Soros warned of financial chaos in the event of BrexitImage: AP

Unlike then - Soros said - there is now little room for cuts in interest rates to offset the effects of currency deterioration. The UK is now running a much bigger current account deficit, he added. "Sterling is almost ­certain to fall steeply and quickly if leave wins the referendum," Soros said. "I would expect this devaluation to be bigger and also more disruptive than the 15-percent ­devaluation that occurred in September 1992."

After the UK left the ERM, UK interest rates were cut from 10 percent to 5.5 percent. But with borrowing costs at 0.5 percent today, Soros said rates were already at the lowest level consistent with the stability of British banks. This would mean the Bank of England could do little in the event that Brexit led to a recession.

"Too many believe that a vote to leave will have no effect on their personal financial positions. This is wishful thinking. If Britain leaves the EU it will have at least one very clear and immediate effect that will touch every household: the value of the pound would decline ­precipitously. A vote to leave the EU would also have an immediate and dramatic impact on financial markets, investment, prices and jobs," Soros added.

Mixed messages

Not all economists agreed with Soros's assertion that a rate cut would not be possible: economists at JP Morgan, for example, are among those forecasting a cut to zero in August from 0.5 percent now.

Analysts at Goldman Sachs warned earlier in the year that the pound could fall by up to 20 percent if Britain votes to leave the EU.

jbh/bk (AFP, Reuters)