On 10 June 2016, I made a prediction on the outcome of the UK referendum which turned out to be quite accurate, with the projected “remain” percentage to be quite close to the actual number. Refer to my post: https://thecafeinvestor.wordpress.com/2016/06/10/brexit-is-very-real/
Post-referendum, we saw a significant decline in Pound / GBP against the USD (current rate at 1.33):
The currency hit its lowest in nearly 31 years in the early hours of Friday after the referendum results were announced that sent shockwaves across all asset classes globally. However, on Monday sterling further fell below the 31-year low to $1.3221 on speculation that the Bank of England may proceed with a rate cut. Sterling is also at its lowest against the euro since March 2014 at 83.41 pence.
“The move in sterling against the dollar after the U.K. referendum is unprecedented,” John Bilton, global head of multi-asset strategy at JP Morgan Asset Management told CNBC via email
A number of banks have cut their sterling forecast since the vote to leave the EU was announced on Friday. HSBC was the first to announce a change to its sterling outlook. The bank said it expects the currency to fall to $1.25 against the dollar in the third quarter and to $1.20 by year-end.
So how low can GBP go?
Since UK is well-connected with the EU region, let’s explore the historical relationship between USD/GBP and EUR/USD to determine the potential trading range of USD/GBP. We did a quick regression analysis between the two currencies for data points (since 1 Jan 1999) and the summary of the results is shown as follows:
As shown below, the actual USDGBP rate is trading relatively lower than of the forecasted rate of USDGBP based on the results of the regression analysis.
As summarised below, the current rate of 1.33 is below the forecasted rate of 1.5881 and it is very close to the lower bound of the 95% confidence interval of 1.3187 – 1.8576.
If you believe that the market has overreacted to BREXIT, the Pound / GBP is poised to rebound. Further, based on a 95% confidence interval, the downside risk is fairly limited. Nevertheless, since BREXIT is an unprecedented event, the ordinary statistical analysis may not be able to capture the full extent of market events resulting from BREXIT.
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