El-Erian: Sterling may hit dollar parity without a good Brexit plan

Sterling may plummet to parity with the U.S. dollar if U.K. politicians do not secure a Brexit deal with the European Union (EU) that includes a free-trade agreement, Allianz's chief economic advisor has told CNBC.

"Parity is not the base case but, rather a risk scenario. Specifically, sterling could head more towards parity if politicians fail to come up with a comprehensive 'Plan B' (Plan A being to remain in the EU) that maintains a sufficient free trade setup between U.K. and the rest of the EU," Mohamed El-Erian told CNBC via email on Thursday.

Mohamed El-Erian
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Sterling has tumbled by around 13 percent against the dollar since the U.K. voted to leave the EU last month. It fell to a new 31-year low below $1.28 on Wednesday, before trading above $1.29 on Thursday.

"With both the current and capital account in play after the Brexit referendum, sterling is facing a particularly uncertain outlook — and especially as the Bank of England is not in a position to use higher interest rates to stabilize it," El-Erian told CNBC.

"Where the currency eventually settles depends in large part on what, how and when politicians, both in the U.K. and the rest of the EU, come up with an alternative to the setup that has governed their trade relationship for over 40 years," he added.

George Magnus, former senior economic adviser at UBS Investment Bank, also thinks dollar parity is plausible.

"I said before the referendum, it (sterling) would most likely fall by 20 percent and that still looks likely. If the economy really shuddered, parity is quite possible," Magnus blogged on his personal website on Wednesday.

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The U.K. pound neared dollar parity in February 1985, when it traded below $1.05. The dollar was exceptionally strong at the time, in part due to tax cuts and spending increases introduced by then-U.S. President Ronald Reagan.

Now, sterling's move may depend on whether the Bank of England cuts interest rates next on Thursday.

"The chatter on forex desks is that the pound could hit parity with the dollar," ETX Capital CEO Andrew Edwards said in a note Thursday.

"Although not impossible, this seems a little far-fetched as sterling would have to drop considerably from where it is now. Parity would represent an all-time low for the pound," he added.

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