By Frances Coppola
As Brexit day approaches, the exchange rate is on another wild ride. But Brexit is not the only story affecting sterling’s dollar exchange rate. There is another story, too—the “strong dollar” story—that is familiar to readers of this site.
The Brexit story started in January 2013. As speculation grew that the U.K.’s prime minister, David Cameron, would promise an in/out referendum on U.K. membership in the EU if his Conservative Party won the next election, sterling’s volatility rose and its exchange rate started to fall against the dollar. On January 23, 2013, he made that promise.1 Sterling’s dollar exchange rate tumbled from over 1.6 USD to one pound at the beginning of the year to less than 1.5 USD to one pound by the beginning of March.2
But after that, attention turned to other things, such as the “taper tantrum” in May 2013.3 For the next two years, the dollar, not sterling, was the main driver of the GBP-USD exchange rate.
Fast forward to May 2015. Forex markets had been widely expecting the outcome of the U.K. general election to be another coalition government. But unexpectedly, the Conservatives won an outright victory. Although sterling’s dollar exchange rate rose on the news, the election outcome set the stage for Brexit, because Cameron had promised a referendum if he won the election.
On February 20, 2016, Cameron set the date of the vote for June 23 that year.4 Initially, sterling’s exchange rate fell against the dollar. But over the next few months, as opinion polls predicted a “remain” victory, it gradually rose. On the day of the vote, the GBP-USD exchange rate spiked to 1.48, its highest level in 2016.5
But as results came in during the early morning hours on June 24, it became clear that opinion polls were wrong. By a narrow margin (51.9 percent to 48.1 percent), the British people had voted to leave the EU. Overnight, sterling’s dollar exchange rate dropped more than 10 percent, to 1.33 USD to one pound, the lowest level since 1985.6
Later that morning, Prime Minister Cameron resigned. Sterling continued to fall throughout the ensuing leadership contest, reaching a low of 1.2951 on July 9. But after Theresa May was appointed as Prime Minister on July 13, the pound’s exchange rate appeared to stabilize—though it remained relatively volatile, its volatility stayed within a narrower range.
Meanwhile, the Bank of England was keeping a watchful eye on economic developments. Early indicators suggested that business activity had slowed sharply as a result of the vote, which could mean a recession.7 So on August 2 the Bank of England cut interest rates and re-started quantitative easing (QE). The stimulus package was larger than many analysts had predicted, implying that the referendum was causing significant economic damage.8 This triggered another sharp fall in sterling’s exchange rate.
Still, the biggest changes in the GBP-USD exchange rate in 2016 continued to be triggered by political, not monetary actions. In October 2016, Prime Minister May, announced that Article 50 of the EU’s Lisbon Treaty, the legal mechanism by which the U.K. would leave the EU, would be triggered before March 2017. In the speech, she also implied that the U.K. would leave the single market as well as the EU itself. This suggested that Brexit would be more disruptive to business than analysts had expected. Sterling’s exchange rate promptly went into a sustained downward spiral. By October 11 it reached an historic low of USD 1.22 to one pound.
For the rest of 2016, even as the U.S. dollar soared against most currencies it fell slightly versus the British pound. Sterling’s dollar exchange rate was helped by a legal challenge to the Government’s intention to trigger Article 50 without Parliamentary approval. But on December 7 the U.K. Parliament voted to respect the result of the referendum.
In November 2016, Donald Trump was elected U.S. president. After that, although sterling volatility remained high due to Brexit uncertainty, broader movements in the pound-dollar exchange rate had as much do with U.S. monetary policy and the decisions of the Trump administration as they did with the twists and turns of Brexit negotiations.
Early in 2017, it was still not clear what form Brexit would take. All that people knew was that it would be triggered in March, so sterling fell due to Brexit uncertainty. But on January 17, at Lancaster House in London, Prime Minister May laid out her Brexit plan. Although it was a “harder” Brexit than many analysts had expected, sterling rose due to relief that the U.K.’s position was clear.9 In early February, the Bank of England upgraded its growth outlook for the U.K.10 Brexit was perhaps not looking as bad as some had feared.
On March 29, 2017, May signed the letter that would trigger Article 50 and start the two-year countdown to Brexit. Over the next few months, sterling’s exchange rate went on a rollercoaster ride as negotiations commenced between the U.K. and the EU, and the complexity of Brexit became apparent.
But the general trend of GBP-USD throughout 2017 was upwards because of the weakness of the dollar. In contrast, the GBP-EUR exchange rate fell from 1.1514 to 1.079 by the beginning of August 2017, and never regained its previous level.11 The dollar, not sterling, was mainly responsible for the broad trends in the GBP-USD exchange rate.
Within this broader trend, sterling’s ups and downs were still primarily driven by political decisions. In April 2017, concerned that her small majority would hamper her in negotiations with the EU, May called a general election for June 8. Rather than delivering the large majority she hoped for, the election wiped out her small majority and left her government dependent on support from a tiny political party in the U.K.’s province of Northern Ireland, the Democratic Unionist Party (DUP).12 Sterling fell slightly against the U.S. dollar when the election result was announced, though the weakness of the dollar at the time minimized the decline.13
In September 2017, May gave a speech in Florence, Italy, which analysts expected would soften the approach to Brexit laid out in her earlier Lancaster House speech. Sterling rose in anticipation of a softer Brexit. But although the speech included a proposal for a two-year transition period, it also warned that if a deal could not be agreed the U.K. would leave the EU without one. This was widely regarded as disastrous for the U.K.14 Sterling plunged from USD 1.3575 to 1.1139, though it climbed slowly up again as May continued to negotiate with the EU. On December 8, the U.K. and EU concluded the first phase of negotiations.
Sterling remained strong in the first quarter of 2018, partly because of progress in the Brexit negotiations, but also because of the dollar’s stormy start to the year. But from April onwards, sterling, like other currencies, fell continuously as the dollar soared. Where the GBP-USD exchange rate was concerned, King Dollar trumped Brexit.
As 2019 dawned, the dollar weakened due to a declining U.S. growth outlook. Sterling strengthened despite growing concerns that a no-deal Brexit might be the eventual outcome.
The history of the GBP-USD exchange rate over the last few years shows that although domestic political uncertainty over Brexit made sterling’s currency exchange rate volatile, the behavior of the dollar is what determined the longer-term exchange rate trend. Despite Brexit’s significant impact, Federal Reserve monetary policy and the decisions of the U.S. government have been more powerful drivers of the GBP-USD exchange rate.
With 17 years experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “David Cameron promises in/out referendum on EU,” BBC https://www.bbc.co.uk/news/uk-politics-21148282
2. USD-GBP, FRED Economic Data https://fred.stlouisfed.org/series/DEXUSUK
3. “Taper tantrum,” Investopedia https://www.investopedia.com/terms/t/taper-tantrum.asp
4. “EU referendum timeline: Countdown to the vote,” BBC https://www.bbc.co.uk/news/uk-politics-33141819
5. “EU referendum: Sterling hits five-month high against the dollar,” City AM http://www.cityam.com/243756/eu-referendum-sterling-hits-five-month-high-against
6. “Pound slumps to 31-year low following referendum,” The Guardian https://www.theguardian.com/business/2016/jun/23/british-pound-given-boost-by-projected-remain-win-in-eu-referendum
7. “UK services sector contraction adds to recession fears,” The Guardian https://www.theguardian.com/business/2016/aug/03/uk-services-sector-contraction-adds-to-recession-fears-pmi
8. “Bank of England cuts interest rates to 0.25% and expands QE,” The Guardian https://www.theguardian.com/business/2016/aug/04/bank-of-england-cuts-uk-interest-rates
9. “Europe sees UK set for ‘hard’ Brexit after May speech,” BBC https://www.bbc.com/news/world-europe-38650877
10. “Monetary policy summary and minutes of the Monetary Policy Committee on 1 February 2017,” Bank of England https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-summary-and-minutes/2017/february-2017
11. “Brexit Pound Exchange Rate Tracker,” ExchangeRates.org https://www.exchangerates.org.uk/brexit-pound-exchange-rate-tracker
12. “Brexit timeline: events leading to the UK’s exit from the European Union,” House of Commons Library https://researchbriefings.parliament.uk/ResearchBriefing/Summary/CBP-7960#fullreport
13. “Brexit Pound Exchange Rate Tracker,” ibid.
14. Pound dropped half a percent after Theresa May’s Florence speech,” Independent https://www.independent.co.uk/news/business/news/pound-sterling-latest-exchange-rate-theresa-may-florence-speech-brexit-leave-eu-a7961611.html
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