It’s often the case that the forex market and its free-floating exchange rates are impacted by a number of macroeconomic and geopolitical factors simultaneously, from inflation and interest rates to the trade relations that exist between different nations.
So, can we measure the impact of Brexit on the foreign exchange, and if so, how has it affected major currencies such as the British pound (GBP), US Dollar (USD) and the Euro (EUR)?
A Look at the Current State of the Forex Market
The current FX market is largely characterised by depreciating currency values, as inflation and the cost-of-living continue to rise globally.
This has been particularly prevalent in the UK in the developed world, where inflation peaked at 10.1% in July and could peak above 11% during the winter.
By definition, rampant and sustained inflation devalues national currencies by directly reducing purchasing power. This, in turn, discourages international investment and diminishes capital inflows into a particular country, creating further macroeconomic volatility that undermines real-time exchange rates.
This also increases the risk of so-called “stagflation”, which describes a scenario where high inflation persists and ultimately drives down earnings and reduces GDP growth. Given that real terms earnings in the UK have already declined by 3.0% in June this year, there’s the clear potential for more forex instability in the weeks and months ahead.
Is Brexit a Factor?
While inflation began to soar following Russia’s invasion of Ukraine in February (and has since been exacerbated in the UK by Prime Minister Liz Truss’s disastrous economic policy), we should not overlook the continued impact of Brexit on FX market volatility.
Ever since the UK electorate voted by a small majority to leave the EU in June 2016, the GBP has traded within an ever-depreciating range, while it has yet to trade above its pre-Brexit level.
While the EUR has also weakened noticeably during this time, it has generally performed better than the pound and strengthened further when the UK signed a provisional free-trade deal with the single bloc at the end of 2020 (although this remains precarious and continues to create significant economic and market uncertainty).
Conversely, the USD has continued to outperform both the GBP and the EUR, showcasing robust growth thanks to its underlying economic strength and status as the world’s primary reserve currency.
To this end, forex traders watched as the GBP sunk to an all-time low against the USD in late September, with this accelerating a trend that has been observed ever since the Brexit vote.
The Last Word – Brexit and Trade Relations
Despite the tentative agreement of a free-trade agreement between the UK and EU in 2020, imports and exports remain considerably more complex now that Britain is classed as a ‘third country.
Certainly, new customs and regulatory borders are in existence, increasing the cost of trade while also placing an additional strain on a global supply chain that has already been compromised by Covid-19.
Make no mistake; this increased economic and geopolitical tension between the two parties has directly impacted on exchange rates, particularly as trade flows have also been disrupted as a result.
This is unlikely to change any time soon, with Brexit not yet fully resolved and the GBP continuing to fight a number of challenging battles simultaneously.
