The Chances of a Hard Brexit (and Plunging Pound) are About 25% FEATURED

The extraordinary uncertainty over the outcome of Brexit makes a fundamentals-based valuation of the GBP/USD exchange rate exceptionally challenging. What follows is an effort to describe the odds of three different Brexit outcomes - a hard-Brexit, an orderly Brexit, and a second referendum - from the GBP/USD exchange rate. The resulting estimates suggest about a 25% chance of a hard Brexit that would likely cause a 10-15% depreciation of the pound.

The Impact of a Hard Brexit will Surely be Severe

The International Monetary Fund has, by far, the most careful and rigorous forecasts of Brexit’s impact on the UK economy. It has projected that a hard Brexit, where the UK leaves the EU without an agreement on trade and capital flows, would reduce the long-term level of UK GDP by about 6.5%. As shown on the right (taken from the IMF’s blog), the IMF’s estimate is around the midpoint of other estimates on the effect of a hard Brexit.