Credit ratings agency Standard & Poor’s has warned that the pound could lose its place as one of the world’s most important reserve currencies if Britain votes to leave the European Union in June.
In a new report, titled “Brexit Is A Risk To The Reserve Status Of Sterling” S&P argues that the impacts Brexit could have on both foreign direct investment and general capital inflows into the UK market could put the pound’s status as one the world’s top reserve currencies in serious jeopardy.
In a statement alongside the warning, S&P Global Ratings analyst Frank Gill said: “Sovereigns controlling a reserve currency benefit from extensive external and monetary flexibility, which supports government creditworthiness. A U.K. departure from the EU could put sterling’s reserve status at risk by deterring foreign direct investment and other capital inflows into the U.K.”
The report adds: “Because last year’s current account deficit was the world’s second-highest in absolute terms, any decline in capital inflows into sterling-denominated assets would most likely produce two effects: First, it would weaken growth; and second, it would weaken the pound, possibly considerably, given that central bank reserve managers might prefer to reallocate toward assets with less headline risk than the pound.”
As its stands, sterling is — alongside the US dollar, the Japanese yen, and the euro — one of the four currencies that are part of the International Monetary Fund’s reserve basket. That means, generally speaking at least, that central banks around the world hold onto substantial amounts of the currency for the purposes of international trade.
While the IMF currently considers four currencies to be part of its basket, the Chinese yuan will officially become part of the basket in October this year. Internationally, the Canadian dollar and the Swiss franc are also widely considered to be reserve currencies.
The pound losing its status as a reserve currency could be damaging to the UK in two key respects, S&P says. The first is that servicing external debts would become far more expensive should the pound lose its reserve status.
“Given the U.K. has the overall fifth-highest public plus private gross external debt burden in the world (412% of GDP), lower real external financing costs are clearly a comparative advantage to the U.K.’s very large financial services sector versus non-reserve jurisdictions,” S&P says.
Secondly, so-called seigniorage receipts, essentially the amount of money the UK government makes by issuing the pound, especially the difference between the face value of coins and their production costs, would decline, having a material effect on GDP. Seigniorage receipts currently account for between 0.2 and 0.6% of UK GDP, S&P says.
The pound has been extremely volatile in the lead up to the Brexit referendum, frequently moving large amounts on small pieces of news. On Tuesday for example, sterling gained more than 1% after an ORB poll showed remain taking a strong lead. Early in 2016, sterling slumped hitting a near ten-year low in February after former Mayor of London Boris Johnson made his much-anticipated decision to back Brexit. Since then however, it has climbed by more than 5%, and is currently at a 16-week high, up 0.2% on the day against the dollar to trade at $1.4705.
Here’s how the pound’s 2016 rollercoaster looks: