Since the announcement of the snap election by Theresa May in April, we have seen a surge upwards across all GBP pairs. This week we saw GBPUSD made a new higher high, reaching 1.3125, the highest its been since the 22nd of September 2016. Structurally and technically GBPUSD remains bullish with no clear sign of a reversal and trend change yet, however there are large list of fundamental factors which could negatively affect the GBP over the next 12 months:
- UK growth has remained relatively slow. Official GDP growth slowed from around 2.5% (annualised) in Q4 to below 1% (annualised) in Q1 and analysts track growth at 1.8% (annualised) in May, having slowed from 3.1% (annualised) in December (Exhibit 2). Investment banks are forecasting GDP growth to remain at or below-trend for the remainder of the year (with Q2 growth forecast at 1.6% annualised).
- Despite a rise in inflation, interest rate policy is expected to remain on hold through this year. Since the MPC policy announcement on June 15, front-end rates have moved higher and the market is now assigning more than a 50% probability that the MPC increases the policy rate at the November 2017 meeting (Exhibit 3). Goldman sachs research division expect the BoE to tighten through credit or ‘macro-prudential’ policy – such as the increase in the Counter-Cyclical Buffer rate on banks’ UK exposure announced by the BoE’s Financial Policy Committee in late June– which will do less to support Sterling than an interest rate rise. The key risk to an earlier rate rise is a further decline in unemployment (especially if combined with a rise in wage growth). Goldman sachs expect the majority of the MPC will put more weight on the deceleration in economic activity than on the rise in inflation driven by a weaker currency. But admittedly a further decline in the unemployment rate would suggest that weaker GDP growth is due more to weak productivity growth, which would weaken the case for keeping rates low.
- The recent General Election has added to Brexit-related uncertainties and resulted in a weaker UK Government. Brexit uncertainties are unlikely to be resolved quickly. Moreover, the Government requires cross-party support in Parliament to make politically sensitive concessions in order to reach a transitional deal with the EU-27 to smooth the UK’s departure from the EU. This means there is an ongoing risk of a Conservative leadership challenge, another general election and a change of Government. The Conservative Party’s conference in the Fall might bring more clarity on these issues. Below is Goldman Sachs forecast of GBP depreciation against G1o currencies over the next 12 months:
- Here we see GBP is predicted to depreciate the most against the CAD and the least against the EUR over the next year.
What could be a future catalyst for a weaker currency?
There are many possible developments that could push the currency weaker:
- A further deterioration in the political landscape making Brexit negotiations more difficult.
- A moderation in inflation coming from the pass through from weaker energy prices.
- The continued weakening in economic activity.
- A change in investor sentiment regarding the resilience of the UK economy.
What fundamental changes could keep and increase sterling strength?
‘Politics’ have the ability to reverse the apparent fundamental factors which currently give sterling an increased probability of depreciation. in particular, we could expect Sterling to strengthen significantly should a political consensus form about the need to remain in the Single Market (e.g., through a ‘Norway-type’ arrangement). Greater confidence that the UK will secure the transitional deal that we ultimately expect would also support Sterling somewhat. Yet, resolving these uncertainties would require concessions from the UK, including acceptance of the free movement of labour and the jurisdiction of European law, either temporarily (to secure a transitional deal) or permanently (to remain in the European Economic Area, as does Norway), since we do not expect the EU-27 to compromise on these points. The two major political parties currently agree that free movement of labour must end and the UK will leave the Single Market, eventually; if there were to be another general election it could soften the parties’ stance on these issues.
To summarise, it appears that from a fundamental perspective, it is more likely to see the beginning of a bear trend in the GBP, starting in the near future. GBP has made its cyclical July high and with such political uncertainty surrounding Brexit, combined with economic slowdown and an unlikely hood of a rate hike in 2017, we could expect GBP to weaken significantly with many analyst’s forecasting GBPUSD to fall to 1.20. However, nothing is certain in the forex market and with the possibility of political change and new beneficial arrangements with the European union, sterling could make further gains, although this is quite unlikely to happen. One thing is for sure, we can expect high volatility and big moves with the GBP over the next year, so trade with caution and always wait for strong technical confirmations before entering.
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