The pound is tumbling on fears of a no-deal Brexit

Every time it seems more likely that Britain will leave the EU without a deal, sterling falls against the dollar. Boris Johnson, who became prime minister on July 24th, has talked up his willingness to countenance a no-deal exit at the end of October. Since he moved into Downing Street, sterling has lost about 2% of its value on a trade-weighted basis. It is now at a two-year low against the dollar. Expect further declines as exit day approaches.

In truth, the twists and turns of the Brexit saga are not the only reason for sterling’s downward slide over the past few months. In April and May traders began to panic about the effect of a trade war between America and China on global economic growth. That prompted “derisking”—moving money out of countries that are highly reliant on inflows of foreign capital. Britain, which runs a large current-account deficit, saw its currency depreciate. So did Australia and New Zealand, both of which also have large current-account deficits.

In June worries about the trade war eased—only to be replaced by a fresh concern, the health of Britain’s economy. That month the statistics office alarmed analysts by revealing that GDP had fallen in April by 0.4%. Other survey data suggest that Britain registered no economic growth in the second quarter of the year. Together with a series of data releases showing that measures of domestically generated inflation are soft, that makes it less likely that the Bank of England will raise interest rates.

The apparently growing risk of no-deal, however, is driving the most recent bout of depreciation. The strength of this link can be measured statistically. On March 23rd a market opened on Betfair Exchange, a betting website, on whether Britain will leave without an agreement. Punters have so far bet £1m ($1.22m). Since the start of April (when the original Brexit deadline expired), a ten-percentage-point rise in the probability of no-deal on Betfair has been associated with the pound losing $0.03.

This correlation is robust enough to allow for educated guesses about where the pound might land if Britain does end up crashing out. If the same relationship were to hold, the most likely exchange rate against the dollar in the event of a no-deal is $1.06—which would be the lowest value ever recorded.

Yet even that estimate might be too optimistic. In the past fortnight, the correlation has changed: sterling has tumbled even faster as the probability of no-deal has risen on Betfair. That might be because Mr Johnson, who is refusing to meet European leaders unless they agree to scrap the Irish backstop, is risking a particularly acrimonious version of Brexit. If sterling were to keep following this steeper downward trajectory, then the most likely exchange rate in the event of no-deal would be $1.00.

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https://www.economist.com/graphic-detail/2019/07/30/the-pound-is-tumbling-on-fears-of-a-no-deal-brexit