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The Sterling in the post “Brexit” era

​The decision of U.K. voters to leave the European Union will definitely have both long and short term political and economic consequences. One thing is certain; the leave vote’s dominance has rekindled fears of a possible breakup of the European Union, as well as of the Euro zone, and has revealed the shortcomings of the so-called “European ideal” that has been gradually cultivated since the end of the second World War. Only time will tell of course if the long term consequences will be ultimately as severe. In the short-term, however, its impact will be primarily concentrated on the U.K. economy and asset prices, due to the rapidly rising political and economic uncertainty.

Brexit came as a surprise and shocked financial markets initially, despite the ‘no vote’ lead in numerous pre-referendum polls that hinted at a tight race and close finish. The immediate reaction of global financial markets was fierce, as riskier asset prices declined sharply around the world, reflecting the abrupt rise in uncertainty, given the difficulty in estimating the magnitude of the implications, and the risks related with the future of the European Union. The pound had been on a depreciating path since the latter part of 2015, as the market adjusted its expectations to the most recent forward guidance by the Bank of England that did not project rate hikes in the short-term. Brexit is a serious exogenous shock that could impact asset prices and, more specifically, the pound through a number of channels.