British Pound overvalued? At levels above 1.5500 GBP is overextended forecast BMO Capital
The British pound sterling vs US dollar exchange rate has appreciated by 7.4 pct since the 8th of July. The rate was seen at 1.49 on this date and is today quoted at 1.59.
The pound to euro exchange rate has meanwhile appreciated by 3.36 pct since July the 31st when it hit 1.1435; the exchange rate is now quoted at 1.1864.
The question on everyone's lips is now whether the UK currency has overheated.
PS: The above quotations are wholesale; your bank will charge a discretionary spread to the figures. However, an independent FX provider will guarantee to undercut your bank's offer, thus delivering more currency. Please learn more here.
Sterling forecasted to fall back
Analyst Stephen Gallo at BMO Capital Markets has today dealt with the question of Sterling's valuation saying the currency is caught in a fine balancing act.
His gut instinct is however that a correction lower against the US Dollar is due.
Writing to clients today Gallo says:
"Above $1.5500 in GBP/USD, we believe that the risks facing the GBP are skewed more to the downside, leaving room for sterling to fall back before year-end, and heading into Q1 2014.
"The market has probably over-estimated the extent to which the BoE is likely to make use of the interest rate channel through tighter monetary policy in order to achieve its goals and avoid triggering its self-imposed CPI ‘knock-out’.
"The BoE has an entirely new range of macro prudential tools which it can lean on instead, should economic developments warrant."
At the heart of the case for an overpriced British pound is the observation that "there is a substantial degree of misinterpretation as regards the BoE’s unemployment rate threshold: it is neither a target nor a trigger for interest rate hikes. It is merely a point of consideration," says the analyst.
The Euro vs Pound exchange rate
In view of the recent upside in UK rates, BMO Capital think that the risks of there being modest-to-moderate downside macro economic data surprises in late-Q3/early-Q4 are reasonably high.
Gallo goes on to say:
"If the BoE did have a preference for a level in EUR/GBP, we believe it would for the moment be stable at about current levels or perhaps slightly higher, around the average over the last 5 years (roughly £0.8500).
"Unwanted exchange rate volatility could seriously erode the BoE’s ability to appropriately calibrate monetary policy for the UK and create uncertainty for UK corporates."
Risks to the UK recovery
Outside of the impact of higher UK rates, fragmentation within Europe’s banking system and the potential for additional bank funding constraints over a 3-6-month horizon are amongst the most prominent downside risks facing UK growth.
"All in all we believe a substantial chunk of the 2013 improvement in UK activity would not have been possible without a high degree of monetary stimulus already in the system. This leaves open the possibility that both the GBP and UK rates will from time to time overestimate the extent to which any recovery in UK conditions is derived purely from self-sustaining forces," says Gallo.