Britain’s potential exit from the European Union, euphemistically called Brexit, has been riveting financial markets recently.
Prime Minister David Cameron has called a June 23 referendum on Britain’s future in or out of the EU after winning concessions in Brussels last week, giving the country a “special position” in the bloc.
Cameron wants Britain to stay but not every British citizen is behind him.
Moreover, some cabinet officials and members of his own Conservative party are opposed to the idea.
Among them is London’s popular mayor, Boris Johnson, who has been publicly campaigning for Brexit.
The financial markets are in a state of shock.
Johnson has been responsible, directly or indirectly, for a 2.44 percent tumble in the pound sterling against the US dollar.
The financial market as a whole is concerned that the British unit is only at the beginning of what could be a long, precipitous slide.
Analysts are watching the pound/greenback curve for any signs of upheaval.
The exchange rate between the two major currencies has typically held up at plus or minus 1.5 percent.
In the 2,646 trading days in the past decade, there have been only 36 times when the pound sterling lost more than 1.5 percent.
The possibility of that decline repeating itself is just 1.36 percent.
In the 5,266 trading days in the past 20 years, the pound has lost more than 1.5 percent against the greenback just 79 times.
When the exchange rate closed 1.78 percent lower from the previous day, it provided a rare opportunity.
As a result, the implied volatility rose to 7.7 percent.
Some traders have used it to realign their positions.
Investors with a high demand for the pound and with a long-term horizon may consider adjusting their strategy using the “average cost” method.
If we look at a longer term chart, we will see that the overall volatility of pound/US dollar has been about 1.3753 to 1.7166 since 2009.
Since serious discussions about Brexit took off in 2014, the divergence of opinions has remained largely unchanged.
Still, its impact on the British currency has been dramatic.
Surveys show more British citizens want their country to stay in the EU than want out.
Many big companies have expressed concern that investment and employment will suffer in the event of Brexit and that the economy will face significant risks.
In mid-January the pound sterling slipped to 1.4080 against the US dollar, a short-term resistance level.
It fell to 1.3503 in January 2009.
At present, the 50-day moving average is flirting with the resistance level.
That suggests the exchange rate will continue to face volatility in the run-up to the June referendum.
Investors should stay prudent.
This article appeared in the Hong Kong Economic Journal on Feb. 25.
Translation by Myssie You
[Chinese version 中文版]
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