A decade after Britain’s vote to leave the European Union, sterling remains trapped in an awkward middle ground. It is no longer in freefall, nor has it recovered the status it enjoyed before the referendum.
Instead, the pound has settled into something less dramatic but arguably more significant: a persistent valuation discount reflecting weaker long-term growth prospects and a political risk premium that refuses to disappear.
That is the conclusion of new research from Bloomberg Intelligence, which argues that while it would be simplistic to blame every move in sterling on Brexit, the referendum has fundamentally altered the UK’s economic trajectory and, with it, the currency’s long-run equilibrium.
The pound has underperformed the EUR and the USD
Markets have often been accused of short memories. Sterling suggests otherwise.
Over the past decade the pound has underperformed both the dollar and the euro. Against the dollar, sterling averaged around $1.30 in the decade following the referendum, compared with almost $1.67 during the previous ten years. Against the euro, the average exchange rate weakened from €1.39 before Brexit to around €1.19 afterwards.
The easy explanation is Brexit itself. The more interesting one is what Brexit has done to the underlying drivers of the currency.
“Sterling has trailed both the dollar and the euro, on average, over the 10 years since the Brexit referendum,” write Audrey Childe-Freeman, Bloomberg Intelligence’s head of FX strategy, and associate analyst Thinh Nguyen. “While trying to attribute that underperformance solely to the UK’s divorce from the EU would be wrong, its negative economic impact has come back to haunt the pound via cyclical and structural channels.”
Those channels extend beyond trade. Bloomberg Intelligence points to slower trend growth, weaker productivity, higher inflation and repeated bouts of political instability, all of which have reduced international confidence in UK assets. A June Bloomberg Economics study cited in the report estimates Brexit has lowered UK GDP by between 2 and 4 per cent.
Sterling’s expectations are less compelling for traders
Currencies ultimately reflect expectations about future returns. Britain’s problem is that those expectations have become less compelling.
The UK’s inflation performance illustrates the point. Consumer prices have risen faster since 2016 than in the preceding decade, partly reflecting sterling’s initial depreciation and higher import costs. But Brexit cannot shoulder all the blame. The pandemic, energy shocks and global supply-chain disruptions have also reshaped inflation dynamics. Even so, the UK has struggled to convince investors that its growth model has become more resilient outside the single market.
