Putting recent British pound declines in historical perspective.
Although the pound fell over 14% in the days following the Brexit vote, the British currency is down over 30% since 2014.
For traders investing in British pound ETFs like CurrencyShares British Pound Sterling Trust ETF (NYSEARCA:FXB) and U.S. corporations with assets in the U.K., a 30% drop is devastating. Brexit only exacerbates the situation as it's likely the Bank of England will continue weakening the pound as it steps up its easy monetary policy.
Since 2009, the Bank of England has held its official bank rate steady at .5% to stimulate the British economy by encouraging banks to increase lending.
The BOE's easy monetary policy also consists of an asset purchase program whereby the BOE buys gilts (the British version of U.S. Treasuries), and the effect of these purchases drives bonds yields lower.
Lower rates of return typically drive capital out of a country as investors search for higher yield elsewhere. In the case of the British pound, this simply translates into selling pound denominated investments for investments denominated in other currencies that offer a higher yield.
The result: A weaker pound.
The asset purchase program can also have a negative effect on corporations since corporate debt is benchmarked to the 10-year gilt. As the 10-year gilt yields fall, corporate yields fall as well, making them a less attractive investment.
Brexit will likely lead to more BOE monetary easing.
Sure we may get some spikes in the pound or yields from time to time, but the overall theme in Britain will be an easy monetary policy for the remainder of 2016 and at least the 1st half of 2017.
Any British pound gains may be limited and dependent on the amount of the BOE stimulus; we may see a sub 1.30 on the pound. And if the Fed hikes interest rates and remains hawkish into 2017, the divergent monetary policies between the U.S. and the U.K. could drive the pound to 1.20 or below. For more on the Fed outlook following the July meeting, check out my article: The Fed Held Off, Now What? 3 Things To Watch For If The Fed Is Going To Hike in 2016.
An August rate cut is likely priced into the markets already.
With such a massive depreciation in the British pound since Brexit, the expectation of lower rates is priced into the market already.
However, the amount of August monetary easing is not priced in; nor is the possibility that the BOE does nothing.
What to watch for:
All eyes will be on BOE President, Mark Carney to determine whether the asset purchase program will be expanded, and if so, by how much and for how long.
If the BOE stimulus disappoints the market, look for the pound to spike higher. This rally may be short-lived, however, since it's likely the BOE statement will be quite dovish, signaling an open door to more easing in the coming months.
In short, expect more currency market volatility, making investing in the U.K. and hedging the pound far more challenging.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.