British pounds and Euro banknotes are pictured in a bank at the main train station in Munich, Germany, June 24, 2016 after Britain voted to leave the European Union in the EU BREXIT referendum.MICHAELA REHLE/Reuters
The big question for pound traders may have been answered, but the outlook for the currency is murkier than ever.
Sterling dropped 1.3 per cent to $1.3509 (U.S.) at 4:06 a.m. in Tokyo on Monday. That extended an 8.1-per-cent tumble to $1.3679 on Friday, the biggest drop on record and almost double the 4.1-per-cent decline on Black Wednesday in 1992, when the United Kingdom was forced out of Europe's exchange-rate mechanism.
The pound suffered a record one-day loss on Friday after Britain voted to leave the European Union, pushing it to the lowest level since 1985. Investors face months of uncertainty – the mechanics and terms of Britain's exit are yet to be determined, and the nation's political leadership during the negotiations is unclear after Prime Minister David Cameron announced his resignation. Scotland is agitating for independence and the opposition Labour Party has been thrown into chaos by the historic vote.
Analysts say all this spells further losses for the pound.
"People are finding it difficult to comprehend what Brexit implies for the future – we don't know yet what the magnitude of the shock will be," said Steven Barrow, head of G10 strategy at Standard Bank Group Ltd. in London. "So far, in terms of sterling-dollar, we've seen half the decline we're likely to see this year."
The chance of a Brexit has dominated pound trading in 2016, and sterling was the most visible casualty as Britain's decision to quit the EU rippled through global markets on Friday. While a weaker currency may boost domestic exporters, it could increase prices for consumers and complicate the Bank of England's efforts to meet its inflation remit. And it may also ramp up pressure on politicians to speed up decisions on what steps to take next.
"From here, a 10 per cent fall relative to the U.S. dollar seems about right," Kit Juckes, a London-based strategist at Société Générale SA, said in a Bloomberg Television interview on Sunday. "The low point will be somewhere between $1.20 and $1.25. However much you want to say the U.K. will survive and calm down, the uncertainty is going to have an economic impact, and the uncertainty is magnified at the beginning by the politics."
While pro-Leave politicians sought to minimize the financial turmoil seen on Friday, recent European history has shown how politics can start driving markets, only for the relationship to swiftly reverse. During the euro zone's debt crisis at the start of the decade, investors played the role of vigilantes by dumping sovereign bonds and pushing governments to act.
"There's a lot of questions that need to be answered right now – the longer this takes the more the pressure is going to be on the pound," Vasileios Gkionakis, head of currency strategy at UniCredit SPA in London, said in a Bloomberg Television interview on Sunday. "The reaction we saw in the market on Friday was largely the result of speculative activity. What we haven't really seen is the flow, the reversal of flows coming out of the U.K. When these start unwinding I'm pretty sure that we're going to see some enormous pressure on the pound."
A drop below $1.20 is possible, according to Mr. Gkionakis.
Friday's price moves are in line with what economists predicted would happen following a Brexit decision. In a Bloomberg poll earlier this month, most participants saw the pound plunging below $1.35 the day after a vote to quit the EU.
Bank of England Governor Mark Carney sought to restore confidence on Friday by saying that officials will take any steps needed to secure stability. Even that may not be positive for the pound, with investors having boosted bets on an interest-rate cut since the referendum, a move which would likely weaken sterling further. Futures suggest a 40-per-cent chance of a rate reduction as soon next month, up from 11 per cent on Thursday.
"The U.K.'s natural inclination over the past century has been to let the pound take the strain during times of crisis," said Simon Derrick, chief currency strategist at Bank of New York Mellon Corp. in London. "Given events over the weekend, that probably means more pound weakness at the start of this week. To me, that's a sign that U.K. markets are working efficiently and doing what they're supposed to do."