A no-deal Brexit could plunge the pound to parity with the US dollar, according to investment bank Morgan Stanley.
A hard line approach taken on Brexit by both the favourite to become Britain’s next prime minister Boris Johnson and his rival Jeremy Hunt pushed sterling down to a 27-month low on Tuesday.
Financial market watchers fear that an abrupt end to the UK's European Union membership could send sterling spiralling to new lows, beating the all-time low set in 1985 when the pound almost reached parity with the dollar.
“The pound has come under intense selling pressure since Prime Minister May withdrew from her party leadership position, leaving markets with increased concern that the UK may be heading towards a harder Brexit,” the bank said in a research note.
“Should this scenario materialise, pound-dollar could fall into the $1.00-$1.10 range.”
It added that under outgoing Prime Minister Theresa May’s leadership, markets thought a soft Brexit or even a second referendum was much more likely.
“Should the new PM strike a deal with the EU and bring it through parliament, the pound may rally. The stance of the Labour party will be important for the pound’s valuation too. Should the Labour leadership move closer to a pro-EU approach, the pound may reach $1.35,” said Morgan Stanley.
The pound has been the world’s worst-performing currency since the 2016 EU referendum.
In November, the Bank of England warned sterling could fall below parity with the dollar under a no-deal scenario.
Business magnate and Virgin boss Richard Branson warned last Thursday that the pound could “collapse to parity [one for one] with the dollar if there is a hard Brexit”.
As market fears mount over a no-deal, the government suffered a defeat on Thursday as MPs backed an amendment preventing the suspension of parliament. There had been fears that Boris Johnson could have so-called 'prorogued' parliament, essentially suspending it in order to push Brexit through.
The UK’s independent economic forecasting body also warned on Thursday that Brexit could push Britain into a sharp recession, with the economy likely to shrink by 2 per cent as early as 2020 in the event of a no-deal Brexit.
In its latest fiscal report, the Office for Budget Responsibility (OBR) warned political uncertainty was driving away investment and trade.
“Together, these push the economy into recession, with asset prices and the pound falling sharply.
“Real GDP falls by 2 per cent by the end of 2020 and is 4 per cent below our March forecast by that point.”
Meanwhile, expected volatility in the pound is higher compared G10 currencies.
Reflecting the political unpredictability that is Brexit, the pound has bucked a trend of low volatility in the multi-trillion-dollar-a-day market for foreign exchange.
Sterling matches emerging market currencies in Mexico and Brazil, such is the dim uncertainty clouding Britain.
According to an economist at a German bank, sterling volatility ought to be much higher given the huge risks involved in the UK tearing itself away abruptly from the EU on October 31.
Esther Reichelt, a currency strategist at Commerzbank, told Bloomberg that there was a similar surge in volatility in the run-up to the original Brexit deadline of March 29 earlier this year.