If Britain votes to leave the European Union on Thursday, it is widely acknowledged that the pound will dive off a cliff, with estimates of the fall ranging from around 5% to as much as 20% in the immediate aftermath. It has also been largely forecast that the euro will also suffer as a consequence of a Brexit.
But according to a new note from Deutsche Bank, the impact of a Brexit on the euro might not actually be quite as bad as many people imagine.
In the bank’s daily foreign exchange update, strategist George Saravelos argues that there are 6 crucial reasons why the euro won’t collapse against the dollar.
Saravelos says that the biggest downward move in the euro, Deutsche Bank expects, is around 2% and argues that it could actually end up going higher in the medium-term after a Brexit: “We wouldn’t anticipate a bigger than 2% initial move lower in EUR/USD on “Brexit” and the risk may be that EUR/USD ends up squeezing the other way.”
These are the key reasons why the bank sees minimal weakness in the euro:
- If Britain chooses Brexit, it will all but guarantee no rate hike from the Fed in July. US yields will drop. On the other hand, Deutsche says it is “already pricing 15bps of depo cuts from the ECB and are unlikely to price more – Draghi has suggested that aggressive rate cuts are unlikely.”
- The euro generally performs better than the market in periods of uncertainty and risk aversion. “Europeans have historically repatriated foreign assets during periods of uncertainty and the correlation between equity markets and the euro trade-weighted is negative.”
- Markets will finally start to look at the “political risk premium” in Europe and the US given the rise of Trump, Brexit, and other anti-establishment political events, such as the near defeat of far-right candidate Norbert Hofer in Austria’s presidential candidate.
- There is not really a single event that could cause significant stress in the euro area, Deutsche argues. “It is difficult to identify an immediately relevant liquidity or credit event in the financial system that causes systemic stress in the Euro-area. The central bank liquidity backstop is strong and public statements the day after the referendum will re-enforce this.”
- “The time lags and inter-play between Brexit and other EU political events are long and unquantifiable. There is no other referendum planned in Europe. If the Spanish election this Sunday is close to expectations the market may struggle with identifying a catalyst for a continued re-pricing of risk.”
- Finally, Deutsche Bank points out that during the last time it looked as though a country may leave the EU — during the Grexit scare in 2015 — the euro rallied. You can see Deutsche’s chart to show that below:
Polls ahead of the vote are mixed.
Late last week it looked like the Leave camp was taking a solid lead, but since the tragic murder of MP Jo Cox, polls have shown a swing back towards Britain staying in the EU. The most recent poll for the Daily Telegraph showed a solid lead for the ‘In’ camp. Remain leads Leave by 53% to 46%, with 2% saying they don’t know. The poll was carried out by ORB International and had a survey size of 800 people.