If Britain votes to leave the European Union on Thursday, it won’t just affect the pound and the euro. A Brexit would throw the entire foreign exchange market into a tailspin, hitting safe-haven currencies like the Swiss franc and the Japanese yen particularly hard.
Experts anticipate significant volatility. Nick Parsons, lead investment strategist at the National Australia Bank, predicts a repetition of Black Wednesday, when the British pound was forced out of the European Exchange Rate Mechanism in 1992 because it lost 4.3 percent of its value.
Sören Hettler, an analyst at DZ Bank, warned against being taken in by the relative calm before the storm.
“The rates on the foreign exchange market do not adequately reflect the risk of a British exit from the European Union,” Mr. Hettler told WirtschaftsWoche, Handelsblatt’s sister publication. As a consequence, there’s danger of considerable volatility, he said.
Goldman Sachs has forecast an 11 percent drop in the value of the pound compared to a basket of currencies from other industrial economies. Back in February, Goldman predicted a 20 percent decline. Columbia Threadneedle has forecast a 12 percent drop.
“In the worst-case scenario, a Brexit triggers a chain reaction that causes political unrest in Great Britain and the European Union and unleashes the euro crisis again.”
According to a survey by Bank of America Merrill Lynch, investors are nervous and have already made preparations for a Brexit, stockpiling the largest cash reserves in their portfolios in 15 years.
Brokers are bracing for a massive sell-off of the pound. According to Handelsblatt’s sources in the financial sector, brokers will man their desks round the clock during Britain’s E.U. referendum on Thursday.
The foreign exchange market is the largest financial market in world. According to the Bank for International Settlements, the daily trading volume in 2013 averaged $5.3 trillion.
Trading occurs not just through stock exchanges, but also directly between market participants, central banks, private banks, hedge funds and brokers.
A run on the pound would also drag down the euro, as investors seek the safety of the U.S. dollar to escape instability in the euro zone. Commerzbank anticipates a four to five percent drop in the euro’s value. Some analysts believe the euro would hit parity with the dollar. Currently, €1 buys about $1.11.
“The option premiums for an increase in the dollar’s value are very high right now,” Thu Lan Nguyen, a currency analyst at Commerzbank, told WirtschaftsWoche.
Investors are already fleeing to the Swiss franc, which has gained three percent in value against the euro since the week’s trading. That’s the biggest appreciation since January of 2015 when the Swiss National Bank, or the SNB, severed the franc’s peg to the euro.
For a strong exporting nation like Switzerland, that poses a serious problem. As the franc appreciates, Swiss products become more expensive for foreign buyers, driving down international demand and potentially hurting the country’s economy.
“We are expecting that there could be turbulence in the event of Brexit,” SNB President Thomas Jordan said at news conference on Thursday. The SNB will intervene to stabilize the market, he said.
But there’s not much more that Mr. Jordan and the SNB can do, as demonstrated by the bank’s decision to maintain an interest rate that’s deep in the negative. Already at -0.75, the SNB can’t cut its rate for deposits much more without triggering blowback in the banking system.
Instead, the SNB would most likely intervene directly in the currency markets, buying up euros with francs to depreciate the latter’s value. Currently, €1 buys 1.09 francs.
“In case of a Brexit, we’re assuming that the market will test a rate of 1.05 francs per euro,” Karsten Junius, chief economist at J. Safra Sarasin in Zurich, told WirtschaftsWoche. “That’s a level that we expect the SNB to bitterly defend against.”
The head of the Danish National Bank, Lars Rohde, used much stronger language than the SNB, announcing at the beginning of the week that the bank will “defend the krone’s exchange rate with all means necessary.” Mr. Rohde is known for speaking clearly and his statements are viewed as credible.
As a country that’s not a member of the euro zone, Denmark is considered a safe haven like Switzerland. But unlike Switzerland, the Danish krone is pegged to the euro, which means the national bank would have to intervene even more aggressively.
The Japanese yen is also considered a safe-haven currency and has appreciated considerably against the dollar and the euro. Anticipating a potential Brexit, the Bank of Japan slashed rates to a historic low of -0.1 percent on Thursday.
If stability of the global financial system is acutely jeopardized, the major central banks of countries like Japan and the United States could form a united front and intervene together.
The European Central Bank and the Bank of Japan have already agreed to reciprocal liquidity assistance in the event of a liquidity crunch at British or euro zone financial institutions. The response depends on how long the turbulence on the foreign exchange market lasts after the potential Brexit.
“In the best-case scenario, the financial markets would quickly realize that the economic skid marks are mostly limited to the United Kingdom,” said Mr. Hettler of DZ Bank. That would require constructive cooperation at the political level, he continued.
“In the worst-case scenario, a Brexit triggers a chain reaction that causes political unrest in Great Britain and the European Union and unleashes the euro crisis again,” Mr. Hettler said. “You have to assume the consequences of such an exit would be considerably more dramatic and would last considerably longer.”
This article originally appeared in weekly business magazine WirtschaftsWoche. To contact the author: email@example.com