HSBC: Here’s why you should watch the euro, not the dollar, when tracking GBP Brexit risks

U.S. President Donald Trump escorts British Prime Minister Theresa May after their meeting at the White House in Washington, U.S., January 27, 2017.Reuters / Kevin Lamarque

• Sterling has been one of the best performers in G20 against the USD over the last year — many point to progress in Brexit negotiations as the driving cause.
• HSBC disagrees — in a note to clients, the bank said it had “for some time” been “bemused” by the strength of GBP-USD.
• The bank said that the pound’s performance against the euro is a more logical barometer of Brexit expectations.

LONDON — The pound’s recovery against the dollar has been a dominant theme in the Brexit debate in the last 12 months.

Despite sluggish growth forecasts, sterling has been one of the best performers in G20 against the USD over the last year, and many point to progress in Brexit negotiations as the driving cause.

HSBC disagrees. In a note to clients, the bank said it had “for some time” been “bemused” by the strength of GBP-USD, a performance which is “at odds with the still-potent risks surrounding the Brexit process.”

The dominant narrative since the pound dropped sharply after the EU referendum has been that GBP-USD tracks the weakness of the pound. Instead, HSBC says, it reflects US weakness, which makes it a poor indicator of Brexit sentiment.

GBP’s performance versus the USD is no different to other currencies

HSBC, Bloomberg, US Federal Reserve

The peculiarity of this chart is that, beyond the initial “shock” drop after the EU referendum in June 2016, GBP has not trodden a particularly independent path compared to other major currencies. Its movements have, more or less, echoed the broader market sentiment regarding the USD.

Cut the Cable: Why EUR-GBP is a better way to measure Brexit progress

While the currency market’s fixation on GBP-USD made it an obvious choice as a barometer of UK sentiment, HSBC proposed that the pound’s performance against the euro is a more logical barometer of Brexit expectations, for reasons including that (as of 2016):

• The UK does three times more trade with the Eurozone than with the US;
• Income flows across the Eurozone/UK border are 44% greater than those between the US and UK;
• The Eurozone accounts for 43% of FDI stock in the UK, compared to 25% from the US.

Why EUR-GBP has been a better barometer of Brexit than GBP-USDBloomberg, HSBC

“Viewed through the optic of a Brexit barometer, the exchange rate acts as one would expect, reacting to most of the key developments in a logical and proportionate way,” HSBC said.

“From a fundamental perspective, EUR-GBP is an alternative but still logical barometer of Brexit expectations.”