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Pound to Fall "Towards Parity" in 2018-2019: J. Safra Sarasin

J Safrin Sarasin Pound forecast

One of Switzerland's oldest private banks warns clients to expect a notable depreciation in the value fo the Pound-to-Euro exchange rate in 2018 and 2019.

J Safra Sarasin's Global Economist Adolfo Laurenti says he expects UK economic growth to decelerate in 2018 due in part to persistently high inflation which will reduce real take-home pay and lower consumption. This is in turn expected to lead the Pound back to multi-year lows against the Euro.

Decline in UK economic activity will however be limited by the ongoing improvement in the UK's manufacturing sector which is expected to expand further, partly due to a the Pound's decline in the wake of the EU referendum which has made British exports more affordable and competitive overseas.

Nevertheless, "our latest forecasts show the British economy to decelerate from 1.5% GDP growth in 2017 to 1.3% in 2018 and 1.2% in 2019," says Laurenti.

Expected Impact on Sterling

Falling growth will deter the Bank of England from increasing interest rates despite their remit to combat high inflation.

They will be too worried about higher interest rates making debt and mortgage repayments increasingly unaffordable as real incomes are eroded by higher inflation.

At present markets are forecasting the Bank to make two additional interest rate rises at some point in the next two years, taking the UK's base interest rate to 1.0%. If expectations for a third are added, the Pound would be expected to rise, if expectations are reduced, the Pound would be expected to fall.

Safra Sarasin inflation graph

The Pound is still yet to recover the ground it lost in the wake of the EU referendum of June 2016, which has pushed up the price of imports and lifted prices for consumers.

"The depreciation of the Pound, which we see close to parity with the Euro by year-end 2019, will keep a lid of consumer spending, as real wages will continue to suffer of headwinds from higher inflation," says Laurenti.

However, one bright spot could be business investment, which Laurenti sees increasing as businesses spend money on preparing for the potential complexities thrown up by the UK's departure from the EU.

"We have become less pessimistic about corporate spending and investment, especially in 2H19 in the aftermath of Brexit, as British companies will have to invest to adapt to the likely disruption in their European supply chains," says Laurenti.

The analyst also notes, "manufacturing output appears to receive some benefit from the depreciation of the pound. Production has rebounded from the setbacks of a few months ago, it yet remains fairly volatile."

Safra Sarasin

The bank is more pessimistic about the UK's prospects of growth than the Bank of England but slightly more optimistic than the European Commission, as the infographic below shows.

 GBP to EUR GDP
The final outcome for Brexit is a major risk factor in the Sarasin forecast which could alter the trajectory for both growth and the value of Pound Sterling going forward.

"Of course, the forecast is at best an educated guess, as the process toward Brexit remains mired in both known and unknown unknowns. Final outcomes will rest on, crucially, what model of partnership will be established between the EU and Britain," says Laurenti.

Clearly a 'Hard Brexit' will impact growth more negatively than a softer Brexit in which the advantages of remaining in the trade and customs union were retained.

Forecasts for the Pound vs. Euro

The Euro-to-Pound exchange rate is forecast at 0.90 by the end of 2017, 0.91 by the end of March 2018, 0.92 by mid-2018 and 0.95 by end-2018.

This gives us a Pound-to-Euro exchange rate forecast of 1.11, 1.09, 1.0870 and 1.05 respectively.

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Sterling Falls Sharply on Inflation Disappointment

The Pound slumped Tuesday, November 14 on the release of October inflation data which showed UK price pressures stalling in the UK, easing pressure on Bank of England policymakers for further interest rate hikes.

Headline consumer price growth remained stable at 3% during October when it had been expected by economists to edge higher to 3.1%, which would have forced Bank of England governor Mark Carney to pen an open letter to the Treasury setting out a plan to return inflation to its 2% target.

Core consumer prices, which strip out movements in more volatile food and energy items, also remained static at 2.7% for the month when they too had been expected to rise by 10 basis points, to 2.8%.

Prices of food and non-alcoholic beverages rose during the October month but gains were offset by falls in the prices of motor fuel and furniture items, according to the Office for National Statistics report.

The Pound extended losses against both the Euro and US Dollar in response to the release, to be quoted 0.22% lower at 1.3086 against the Dollar 0.67% lower at against the Euro, making for a Pound-to-Euro rate of 1.1174.

"With political uncertainty high, it appears unlikely that better than expected data releases can trigger more than short-lived currency upside. As such sentiment is likely to remain in favour of selling GBP rallies in the days to come," says Manuel Oliveri at Crédit Agricole.

 

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