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CURRENCY ANALYSIS

GBP Sterling

Modest recovery of sterling possible next year if Brexit is “soft”.

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In 2017 as well, sterling will mostly be guided by developments on the Brexit front. While this will not leave it immune from the effects of the Fed’s decisions, it should be less affected by them than other currencies, as has already been the case in 2016.

This year, sterling plummeted on the outcome of the referendum held in June (Fig. A), dropping by around 20% against both the dollar (from a high of GBP/USD 1.50 to a low of 1.18, a level abandoned as far back as 1985), and against the euro (from a high of EUR/GBP 0.73 to a low of 0.94 EUR/GBP, a level abandoned more recently in 2009).

The depreciation reflects concerns that exit from the European Union may have strong negative repercussions on the domestic economy: slower growth, higher unemployment, higher inflation, crash in real estate prices, stronger taxation, higher deficit and public debt. According to the estimates published by HM Treasury, the impact would be significantly unfavourable both in the near term and in the medium-long term, to a greater or lesser extent depending on the new trade agreements entered into with the EU and the rest of the world.

However, in a nutshell, the critical difference will be whether the United Kingdom succeeds in retaining access to the single market (soft Brexit) or not (hard Brexit). In the past few months, the intransigent approach taken by Prime Minister Theresa May had raised fears of a hard Brexit lying ahead. As a result, sterling, which had stabilised after its post-referendum crash, resumed a sharp downtrend: GBP/USD exchange rate below 1.30 and EUR/GBP above the 0.85 mark.

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Source:Thomson Reuters-Datastream

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