How Likely is a Brexit and How Much Would it Impact the GBP?

As the day of the vote nears, the foreign exchange market continues to react to the possibility of Britain pulling out of Europe, the Brexit. At present, the vote seems to be hanging in the balance, with no one prepared to predict with any degree of certainty which way it will go. This means increased volatility is virtually certain, and it’s likely that fortunes will be made and lost in the currency exchanges if not in bets on the outcome.

Brexit Vote: What will happen to the Sterling?

On the one hand, we have Christine Lagarde, the well-respected chief of the international monetary fund (IMF), assuring everyone that confidence that the UK will stay in the EU will maintain a stable currency market. Indeed, some say that the future of the EU may depend on Britain’s continued membership.

On the other hand, there has been a significant increase in bets placed with bookmakers on the Leave campaign being successful. This seems to be to some extent driven by recent polls which indicate that the Leave movement is gaining steam. It caused Coral to cut the odds on a Brexit from 5/2 to 7/4, lengthening the odds on Remain from 1/7 to 2/5. William Hill similarly shortened Brexit odds from 12/5 to 21/10, reacting to the number of bets placed by punters.

After polls missed badly in measuring sentiment before some of Britain’s most recent votes, bookies’ odds have become the point of reference for anyone trying to guess the outcome of the June 23 referendum on the country’s EU membership.

Public opinion polls failed miserably to predict the outcome of Scotland’s independence referendum in 2014 while last year’s general election outcome was unclear according to pollsters – but the fact was that the Conservative Party won by a comfortable majority. Having said that, predictions are never clear; much of the final outcome is down to ‘undecided voters’ and whether the ‘worried’ category will feel strongly enough about the outcome to actually participate in the polls.

One problem with polls is that they are based on samples of people who are asked how they would cast their vote – a question that shifts a lot depending on which ‘marketing message’ is dominating in any given week. Another problem with polls is whether some people who don’t really care on the final outcome take part. The number of undecided voters is thought to be about 5 to 10% of those questioned. Those with a strong conviction will more likely to want to vote leave so getting the balance right in samples is tricky as the referendum approaches. Gamblers in contrast take into considering all the information available, including polling stats and ten place bets on the final outcome. Betting is very popular in Britain so the odds are the result of a high number of individuals’ views.

David Stevens, a spokesman for Coral, said “Ten days ago the odds were so firmly in favour of Remain there was talk of bookies paying out early. But since then the money has come in for Leave to such a significant degree, we are hardly taking a bet of any note on Remain.” Betting markets tell us our most likely future, and they are better than any other way of doing that.

Will the United Kingdom public vote to remain a member of the European Union or leave the European Union? The smart money is following the bookies. The odds have shortened recently as the final day approaches. Betfair said Tuesday that while “remain” had been a solid 1/3 favorite (78 percent) last week, the odds have weakened to 4/6 (60 percent). Millions of pounds are being traded overnight. And while ‘remain’ remains a favourite at the present time, the momentum is on the ‘leave’ campaign.

There are several factors at work and influencing public attitude to the referendum. For while Britain remains in the EU, a surprising number of economic decisions are not under British control. For example, Britain does not have an independent trade policy, but has its policy decided in the European Union. Even VAT rates are controlled from Brussels.

Another factor impacting public opinion is the seeming inability of the Chancellor of the Exchequer to handle the economy with any degree of certainty. Reducing the deficit seems to be a moving target, and Osborne gives the appearance of being inept at handling the country’s finances.

Prime Minister David Cameron has been resolute in his support for Remain, but has been seemingly unable to convince the general public of the value of his stance. He was accused of scaremongering and waffling during a recent interview in front of a live television audience on Sky.

Boris Johnson, the would-be successor to Cameron, was campaigning with Michael Gove, the Justice Secretary, in Stratford-upon-Avon. Gove said that an EU Army, set up as a rival to NATO, would likely be the next step for European Union, allowing nations who already do not spend enough on defence to spend even less. He was also scathing when talking about the European Court of Justice and its influence on the British legal system. For his part, Johnson accused the Remain camp of being prepared to give up Britain’s democracy.

The Good Morning Britain show on ITV commissioned a survey recently, to follow up on one that they did a month ago. They found that the Leave proportion had increased from 40% to 45%, while the Remain percentage had dropped from 42% to 41%. As this leaves 14% that did not support either position yet, there is plenty of room still for movement.

Although less than a quarter of Betfair’s total £28.5 million in bets so far have been on Brexit, a far bigger share of recent bets — almost half — are now backing Leave, pushing the chances of a Brexit to 42%, according to the company. Graeme Sharpe, a spokesman for bookmaker William Hill, added: “Over 80% of the money in the last few days has been for Leave. It is very difficult to get people to back Remain.”

How much has this impacted the markets? Yesterday morning Cable retested recent lows of 1.436 against the US dollar. The foreign exchange brokers are anticipating as much as a 20% movement in the markets as a result of the vote, and are guarding their positions appropriately. At any rate, it seems that they will be the winners from the increased trading, as June is normally a seasonal slowdown in foreign exchange. Kian Abouhossein, an analyst at J.P. Morgan, is quoted as saying, “A volatile June driven by uncertainty around the UK’s EU referendum vote could help foreign-exchange revenues.”

Undoubtedly the urging of the UK Independence Party and others to withdraw from the EU is having an impact. The EU allows free movement of labour, and the opportunity for British people to move to other countries within the European Union to work. But this same freedom, exercised in the other direction by foreigners from the EU coming to Britain seems to be one of the strong emotive arguments to withdrawing. When you add to this the refugee crisis which is putting pressure on all of Europe to deal with increasing populations, the nationalistic fervour and desire to regain independence becomes easier to understand.

The outcome is still hanging in the balance. For those interested in the currency markets, the best advice is to keep a close eye on all the events leading up to the Brexit vote, and be prepared to reconsider any preconceptions.

“In an information age where the cost of trading is very low and so much information is available, the betting markets are going to be very efficient predictors,” said Leighton Vaughan Williams, director of the political forecasting and betting research units at Nottingham Business School. If the polls say one thing and the betting markets another, you should trust the betting markets, Vaughan Williams said. In a study published in the Journal of Forecasting, Vaughan Williams studied data related to U.S. elections going back to 2004, and found that the bookies outperformed the polls in every case. “Nobody can step directly into the future,” Vaughan Williams said. “But your best guess as to what that future will be is given by the betting markets.”

The bookies and investors agree: based on the flow of money into these bets there is about a 60 percent chance that U.K. voters will cast their ballots in favor of staying in the EU. By contrast, the latest aggregate of public opinion polls by the respected pollster John Curtice’s “WhatUKthinks.org” site, shows the electorate split 51-49 for leave — too close to call.