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The British Pound: Bank of America Eyes 10% Increase on Bank of England and Brexit Developments

 Image © Melinda Nagy, Adobe Stock

- GBP softens against USD, EUR ahead of BoE, on Brexit factors.

- But Bank of America says "soft Brexit" and BoE hikes are coming.

- May push GBPUSD up by 10%, GBPEUR may rise as much as 5%.

The Pound could rise by 10% against the Dollar and Euro over the coming months as the Brexit saga is brought to an end and the Bank of England (BoE) becomes able to lift its interest rate again, according to analysts at Bank of America Merrill Lynch, who've told clients to buy the British currency.

Pound Sterling has already risen by 4% against the Dollar and by 5% against Euro this year but there's another 10% of upside to come for both exchange rates if Prime Minister Theresa May is able to get her current EU Withdrawal Agreement, or an even softer one, through the House of Commons. 

This will give the Bank of England, which is set to update the market on its thinking about the economy at 12:00 Thursday, a long-awaited opportunity to lift its interest rate again. The BoE last raised Bank Rate in August 2018.

"We recently went long GBPUSD, after re-affirming the likelihood of a sterling-supportive A50 extension. Over the near term, price action can further overshoot cyclical fair value and reach 1.35 on short position liquidation flow alone," says Kamal Sharma, a strategist at Bank of America, in a note to clients.

Prime Minister Theresa May has requested a 90-day extension to the Article 50 negotiating window intended to run between March 29 and June 30, although this still needs to be approved by the EU 27 and Brussels has already came out against an extension beyond the date of the May European parliament elections.

There has also been speculation that some countries could reject it if they're unable to force certain conditions onto the UK, which could include a demand for another general election or one for another referendum. Ultimately, a lot will be determined by whether the EU Withdrawal Agreement passes the House of Commons on the next asking. 

"We concede that the path towards a Brexit solution is unlikely to be smooth but in our view, a vote in favour of the Withdrawal Agreement or an extension of A50 present upside," says Sharma. 

Unless and until an extension is agreed the course of action currently enshrined in law will see the UK leave the EU on March 29 and default to doing business with it on World Trade Organization (WTO) terms, which is for those looking to see a stronger Pound Sterling, the worst possible outcome.

Whether the UK leaves the EU with or without a deal is the difference between the country facing trade tariffs and non-tariff barriers on any business done with the EU, and it could also be the difference between whether the Bank of England lifts or cuts its interest rate next. 

A so-called no deal Brexit could potentially undermine the outlook for inflation in the UK by reducing demand further down the line. As a result, policymakers have said they're reluctant to make any changes to interest rates before they know exactly how the Brexit saga will end.

"A move toward 1.40 or above would of course be conditional on flow agents establishing net longs in response to evolving data and guidance by the BoE. Cyclical and policy developments will determine the sustainability of the move, though from a very long-term perspective GBP remains very cheap to the USD in real bilateral terms," says Sharma. 

The Bank of England has raised its interest rate by 25 basis points on two occasions since the referendum in 2016, taking the Bank Rate up to 0.75%, it highest level since before the global financial crisis.

BoE officials have said repeatedly in recent months that elevated inflation and a robust outlook for consumer price pressures mean it'll need to keep raising rates in the coming quarters.

However, for now, they're being sidelined by the Brexit pandemonium in parliament and Sterling has been largely unresponsive to changes in economic data as a result.

Only a resolution of the Brexit saga, which brings certainty about the future, will be enough to see the Pound once again respond to traditional economic drivers. 

"Our proprietary indicators suggest that overall GBP positioning remains light and that GBP remains undervalued (~15%). Our proprietary indicators suggest that asset managers have yet to participate in the GBP recovery and remains significantly below their historical holdings," Sharma says. 

Sharma forecasts the Pound-to-Dollar rate will rise to 1.45 before year-end, which implies upside of 10% from Thursday's level of 1.3160. In the event the Euro-to-Dollar rate was to remain around its current level of 1.13 until year-end, the Pound-to-Euro rate would rise to 1.28 this year. 

However, the market consensus is for the EUR/USD rate to rise to around 1.18 by year-end which, based on Bank of America's prediction of 1.45 for the Pound-to-Dollar rate, would push the Pound-to-Euro pair up to 1.22, which is around 5% above Thursday's market price of 1.1550. 

The Pound-to-Euro is a foreign exchange cross rate that is calculated, at its most basic level, by dividing the Pound-to-Dollar over the Euro-to-Dollar rate. 

"We conclude a bullish bias for GBP given multiple time frame charts favor higher GBP/USD, most weekly charts of GBP crosses have based and are in young upward sloping channels. According to a head and shoulders base, the GBP/USD rally from the December low could extend to 1.39-1.4285. Key to this view is a breakout > 1.3298-1.3363 resistance and remaining above 1.2770," Sharma says, signing off his note to clients. 

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