“If the UK votes to remain in the EU, any further relief rally in sterling could prove short-lived.”
- Oliver Jones Assistant Economist at Capital Economics.
We have become increasingly consumed by the question of how much further the British pound can continue rallying having seen the UK outperform its rivals for a good two weeks now.
There is certainly a sense of trepidation as to whether the move has legs to extend into May.
Those watching the British pound and hoping for better exchange rates from which to transfer money are particularly torn.
The age old conflict of whether to transact at current exchange rates level or hold out for even better levels continues to play out.
On the evidence that we have seen over the past two days we would say that waiting for a stronger exchange rate is likely to seen you get burnt.
Unless you can wait until the second half of 2016, of course, but even longer-term we hear that sterling could struggle, regardless of the outcome of the EU referendum.
Why the Pound is Stronger this April
Last week, the Treasury released its pessimistic assessment of the impact of a Brexit while President Obama warned of the risks associated with leaving the EU and polls showed the remain camp in a double-digit lead.
As a result, the probability of a vote to remain implied by betting markets jumped from the lowest level this year (at less than 64%) to more than 70%, helping to push the pound higher.
Also contributing to the pound’s rise are market-implied expectations that suggest a faster pace of monetary tightening than before, despite the release of disappointing labour market, retail sales and GDP data.
This move indicates that investors think that rate rises will occur much faster following a remain vote than a leave vote.
Why You Should Sell Your Sterling Now
The pound to euro exchange rate (GBP/EUR) is seen trading at multi-week highs above the 1.28 level.
It appears to have topped out just north of 1.29 as the 100 day moving average proves to be a barrier beyond which buying interest is unsustainable.
Technicals aside, according to analyst Oliver Jones, Assistant Economist at Capital Economics, there are a number of fundamental factors that make now the time to buy foreign exchange as the British pound could well be at a limit.
“If the UK votes to remain in the EU, any further relief rally in sterling could prove short-lived,” says Jones, “for a start, while we expect the MPC to raise interest rates a little faster than investors anticipate, we think that the US Fed will hike even more quickly relative to expectations.”
This policy divergence should put the pound under renewed pressure against the dollar at least.
“What’s more, investors’ attention could turn to the huge size of the UK’s current account deficit beyond the immediate aftermath of the EU referendum.
Indeed, the current account deficit hit a peacetime-record level of 7.0% of GDP in Q4.
Jones notes that even the slightly lower figure of 5.2% of GDP for 2015 as a whole is still far above the widely-used 3% rule-of-thumb threshold beyond which imbalances cannot be maintained for more than a short period of time.
“Of course, sterling is now weaker than last year, despite its recent pick up. Nonetheless, the vast size of the UK’s external imbalances suggests that any further strength would be unlikely to last,” says Jones.
In conclusion, the team at Capital Economics don’t believe sterling’s recent rally looks unlikely to be sustained.
While a vote to stay could provide a short-term boost, the current account deficit and outlook for Bank Rate suggest that sterling should fall in the longer term.