Rude Awakening in the U.K. Over Brexit Cost Sends Pound Down

EghtesadOnline: It dawned on investors this week that when it comes to quitting the European Union, safeguarding the economy isn’t Prime Minister Theresa May’s top priority.

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08 October 2016

With the premier signaling that a crackdown on immigration took precedence over membership of the bloc’s single market and European leaders hardening their position, traders responded by driving the pound to its lowest against the dollar since 1985. Following an overnight plunge in Asia, the currency is wrapping up its worst week since the June Brexit vote, reports Bloomberg.

“It’s about a wake-up call,” said Stuart Bennett, head of Group of 10 currency strategy at Banco Santander SA in London. “The U.K. economy takes a hit, the financial sector takes a hit.”

The pound, which dropped to as low as $1.1841 in Asia, traded down about 1.4 percent at $1.2433 at 4:22 p.m. in London. It lost about 4.1 percent for the week.

Signs that the divorce talks -- and terms -- were likely to be bitter emerged in the annual Conservative party conference that ended Wednesday.

Red Lines

An aide to Brexit Secretary David Davis outlined what he called red lines for the U.K., positions that Europeans were bound to reject. He said Britain renounced any contribution to the EU budget; jurisdiction of the European Court of Justice; free movement of labor; and any interference with British lawmaking.

Leaders of France and Germany responded in kind. The EU position is that free movement of people, goods, services and capital are inseparable. “There has to be a price to pay,” said French President Francois Hollande on Thursday. Hours earlier, German Chancellor Angela Merkel warned “there will be no easy negotiations,” signaling a growing reluctance to grant any special terms to the U.K. post-Brexit.

For her part, May said while she wanted “the best deal possible with the EU” on trade she argued she isn’t taking her country out of “the European Union only to give up control of immigration again.”

Official Opposition

The worry for investors is losing membership of the single market would make it harder for manufacturers to trade with a region of some 450 million consumers and that tougher immigration curbs could also end up hurting the economy by making it costlier to produce goods and secure talent. A record current-account deficit also alarms them.

“The currency is now the de facto official opposition to the government’s policies,” David Bloom, global head of currency strategy at HSBC Holdings Plc, said in a report to clients.

For those dumping U.K. assets in the City of London this week, the added fear is that they will pay a personal cost for Brexit. Bloomberg News reported on Monday that the government isn’t planning to give the financial sector -- which contributes about 12 percent of gross domestic product -- special status in the talks, upsetting hopes banks could preserve access to the bloc or at least win an interim deal to ease the cost of transition. May also used her speech to criticize “international elites.”

‘Historic Change’

“It is in everyone’s interests for there to be a positive outcome to the negotiations that is mutually beneficial for the U.K. and the EU, causes minimum disruption to the industry and benefits customers,” said Miles Celic, chief executive officer of lobby group TheCityUK.

Adam Marshall, acting director general at the British Chambers of Commerce, said “in a period of historic change, business communities all across the U.K. need to feel supported, not alienated.”

May’s strategy amounts to a bet that voters’ opposition to immigration outweighs all else and that the economy will find support from easier fiscal policy, new trade deals emerge and banks don’t flee London, said Simon Tilford, deputy director at the Center for European Reform. The political payoff could be more support for her Conservatives at a time when the opposition Labour Party is in disarray.

“May wants to give the people what they want and thinks that the people voted for a hard Brexit and that the economic costs are exaggerated,” said Tilford. “A lot of this has to do with Conservative Party unity and she has a better chance of unifying the party going for a hard Brexit.”

Tory Rhetoric

One pro-EU former minister, who asked not to be named, said Conservative party members are like a group of people high on amphetamines who will at some point come down. Pro-Brexit Foreign Secretary Boris Johnson used his conference speech to attack those still arguing against Brexit.

The rhetoric of the Tory conference was enough to shake up more than markets. When Home Secretary Amber Rudd demanded companies do more to employ locals and monitor foreigners on their payrolls, the response from LBC radio host James O’Brien comparing her call to Mein Kampf went viral.

“When I came to this country it was said human rights were for everyone,” said Ziaurehman Yaqubi, a food-delivery driver from Afghanistan. “If my company were to change its policy that could be something not good for human rights.”

‘Harder Case Scenario’

While economic data this week showed services, manufacturing and construction all topping forecasts last month, giving support to the pro-Brexit camp, Stephanie Flanders of JPMorgan Asset Management sees a tougher road ahead. The chief market strategist there is putting a “harder case scenario” at the heart of her economic forecasts. The International Monetary Fund also this week cut its own projection for growth next year to 1 .1 percent and warned that was based on negotiations going smoothly.

That may explain why Chancellor of the Exchequer Philip Hammond took a detour to Wall Street before heading to the annual IMF meeting. He used a Bloomberg Television interview to predict the economy could blossom outside of the EU and countered talk that the U.K. wasn’t open for business or skilled labor from abroad.

In Washington on Friday, Hammond said investors were finally tuning into the likelihood of Brexit.

“Perhaps what happened this week is the final foot dropped -- they’ve now taken on board that yes, it’s going to happen,” he said. “I expect sentiment will not remain in one direction, it will ride up and down.”