29 June AtoZForex — The unforeseen results of the EU referendum in the UK have far more implications than initially expected. Not only did the UK’s economy, political stability, labour market and the financial markets took a hit, the Brexit impact on GBP Reserve currency status is also a serious case.
Cable took a beating and plunged drastically after it was officially reported that the majority of Britons voted for a Brexit. The implications of GBP’s worst performance in nearly 50 years now affect the pound’s status as a reserve currency.
Why is GBP’s reserve status so important?
Despite, GBP bounced higher again on Tuesday, investors around the world predict a continuous decline on the long term. Why? Well, it is clear that the uncertainty in UK’s politics and economy affects the course of the pound. In fact, analysts fear for a more severe situation. As the Brexit impact on GBP Reserve currency status could be disastrous and knock the pound of this attractive status.
GBP’s status as a reserve currency in the International Monetary Fund (IMF) basket, offers the UK numerous of benefits. One of which is the stability factor, having the reserve status means that the pound is more attractive for international investors. Furthermore, the central banks or governments utilize reserve currencies to purchase assets denominated, as these reserve currencies provide them security in the process.
What happens if GBP losses its Reserve currency status?
As the Brexit impact on GBP Reserve currency status can be fatal, the UK’s international prestige is on the line. Moreover, it could spur the cost of capital for the local businesses in the UK, as investors may decide to keep less UK assets. Commenting on this case, Avinash Persaud of Peterson Institute for International Economics explains: “What people look for is something that’s an insurance policy, an asset that holds its value in times of trouble. You don’t want uncertain reserve assets.”
Therefore, if less global investors are willing to purchase British debt, it will push up the cost of financing in the UK. According to the S&P, for the UK the cheaper costs of capital could equal to 1% of the annual GDP. Considering that the UK has high debt levels.
Worrisome outlook: UK’s concerns on international investors
When assessing the pound’s current circulation in the global system of foreign reserves, it is less than 5%. A much smaller share than the pound used to have in the financial markets. As the GBP only has a small share in the foreign reserves basket, on one hand analysts believe that it will not have a major impact if the currency losses its reserve status. As per example, Kit Juckes of Societe Generale stated that: “At the margin the number of gilts held by foreign central banks will decline, but sterling isn’t much of a reserve currency.”
On the other hand, analysts believe that losing the reserve status will have far stretched implications for the UK’s economy. Considering that the UK relies on international investors to finance its current account deficit. If the attractiveness of the GBP will fade, the UK will lose the constant demand for GBP denominated assets.
What are the odds for GBP losing its reserve status?
On Monday, the ratings agencies Fitch and S&P warned that the demand for the GBP could dwindle by international governments and central banks could dwindle. Thereafter, the ratings agencies made a vital decision to cut UK’s AAA credit rating to AA. Hence, looking beyond the immediate plunge of the GBP and the negative news on the credit rating cut, it is clear that the pound will decline further.
As the wound is still fresh, the markets are not yet able to scale the odds for a definite loss of GBP’s reserve currency status. Stay tuned with AtoZForex for the latest development on the pound as well as the other Brexit implications on the market.
Do you believe that the GBP will lose its reserve status? Let us know down in the comments section.