In the aftermath of Britain’s historic decision to leave the EU, the pound became the barometer of markets’ hopes and fears about Brexit.
In contrast with the more buoyant performance of gilts and UK-listed shares, sterling plunged against both the dollar and the euro following last June’s referendum result, only to stabilise when expectations of a hard Brexit eased or when Theresa May’s government provided reassurances it had a plan.
But now, as the UK prime minister begins the formal divorce process that will take the country out of the EU, the pound is buffeted by many more forces, with trades against its two main currency partners likely to diverge.
With the shock of last June’s result long gone and factors at play ranging from Donald Trump’s travails to uncertainties over continental European elections, Brexit no longer looms over the currency markets as it once did.
The question facing investors is whether the respite sterling has won will prove shortlived as the unprecedented exit negotiations with the EU begin, or whether the nascent shift in the markets proves more lasting.
Kit Juckes, a strategist at Société Générale, highlights the importance of some of the other variables affecting the currency markets.
Among them are uncertainty about whether Mr Trump, who recently failed in his bid to transform the US healthcare system, will be able to enact ambitious tax reform, France’s turbulent presidential election and speculation that the European Central Bank might move to rein in its huge asset purchase programme.
“Brexit in itself isn’t enough to swamp those other big drivers,” Mr Juckes says, although he adds that Mrs May’s negotiations will still influence the pound.
Mr Juckes, like many other analysts, doubts that the pound has much further to fall against the dollar, after having slid 17 per cent since the June 23 referendum, a period when selling sterling against the US currency was the way to make money.
“Once you got to $1.20 it became less easy,” Mr Juckes says of the currency, which on Wednesday traded at about $1.24 and was worth 86.60p against the euro. “It is at the bottom end in terms of valuation [against the dollar].”
His concerns have only been reinforced by questions over whether Mr Trump will be able to deliver the tax cuts and infrastructure boom that enthused markets. “Cable”, the currency market’s shorthand for sterling’s rate against the dollar, has risen 2.9 per cent since mid-March.
Mr Juckes argues that ditching the pound for the euro “looks the easy, better trade” for investors who remain bearish on sterling because of Brexit.
Indeed, many analysts expect the euro to be strong over coming months if the eurozone economy continues to improve and forces the ECB to focus on winding down its quantitative easing and programme. Defeat for Marine Le Pen, the far-right candidate, in France’s presidential election, which is decided in May, could provide a further boost.
“There is a huge prospect for rate support for the euro over the next few months,” says Richard Benson of Millennium Global Investments.
That may spell the end of an unusual period in which the pound’s movements against the dollar and the euro were more often than not in sync.
“Clearly Brexit has been the dominant story and has been the key driver of both exchange rates,” says Ugo Lancioni, a fixed income and currency portfolio manager at Neuberger Berman.
He notes that cable and sterling’s exchange rate with the euro traded more or less in line with each other over the past 12 months, giving a correlation of 76 per cent — compared with just 40 per cent for the preceding nine years.
But now sterling trades against the euro may return to the pattern set by previous periods of divergence — one largely determined by factors in continental Europe. During the European debt crisis in 2011-12, the pound held its own against the dollar but rose against the euro. When European growth lagged behind the UK and the US, sterling again strengthened against the euro, even though it fell against the dollar.
Should the Bank of England also tighten monetary policy the picture could be further complicated by greater sterling strength.
That is not to say the influence of Brexit on sterling is definitively at an end. “As the UK moves closer to exit, it would not be unreasonable to expect higher sterling volatility than in the past,” Mr Lancioni warns.