Pound Sterling Forecasts Slashed at ING after Brextension Derails Bank of England

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- GBP forecasts downgraded at ING after PM May's second Brextension.

- GBP to miss BoE hikes and suffer amid Conservative leadership battle.

- But Pantheon says market too complacent on BoE given outlook for CPI.

The Pound will weaken against the Euro and Dollar over the next six months, according to ING Group, because Prime Minister Theresa May's latest "Brextension" is likely to derail the Bank of England (BoE) from its rate hiking path and store up further political upset for later in the year.

Pound Sterling was once seen recovering much of its post-referendum losses from the Dollar and Euro this year as analysts had envisioned parliamentary backing of the EU Withdrawal Agreement, which would have opened the door to a near-two years of standstill transition during which the future relationship will have been negotiated.

In the intervening period a resilient economy was supposed to facilitate further interest rate rises from the Bank of England, which would have seen Bank Rate reach at least 1% and could have underpinned Sterling at higher levels than those prevailing currently. 

"But with the chances of a near-term resolution to the Brexit impasse looking fairly slim, we think the window for this to happen this year has more-or-less evaporated," says Christ Turner, head of FX strategy at ING Group. "The fact that the six-month extension is unlikely to be long enough to give the BoE a window to hike rates means GBP will miss out on the potential positive catalyst

Prime Minister Theresa May's request for an extension of the Article 50 negotiating window this week shot the rate hike idea out of the water because, even if inadvertently, the extension has ensured the spectre of a so-called no deal Brexit remains on the table potentially until the end of October.

Furthermore, and assuming the PM's EU Withdrawal Agreement is not approved by parliament ahead of the Article 50 deadline of October 31, a fractious Conservative Party leadership contest could also see the market begin to fret about the prospect of a Brexit-supporting Prime Minister making a bid for a so-called no deal Brexit. 

"With markets meaningfully pricing out the risk of a hard Brexit earlier this year, the non-negligible risk of a leadership contest in the Conservative Party in Q3, ahead of the party conference in late-September, and the rise of eurosceptic candidates, such as Boris Johnson, could bring some modest risk premia back into sterling and lead to some light sterling weakness," Turner warns, in a note to clients Friday.

Above: Pound-to-Euro rate shown at weekly intervals.

Turner slashed his forecasts for the Pound-to-Euro and Pound-to-Dollar rates this year on Friday. Sterling is now expected to fall back to 1.1363 against the Euro before the end of September when it was previously expected to hit 1.1660 around then. The exchange is set to remain there for a while before rising to around 1.1560 by year-end.

The Pound-to-Dollar rate is forecast to fall back to 1.27 before the end of September when previously, ING Group had looked for it to trade between the 1.33 and 1.35 levels through the summer months. A Dollar that is also proving stronger than previously envisaged is also a factor in that forecast. 

Above: Pound-to-Euro rate shown at weekly intervals.

"The E.U.'s decision to grant the U.K. a Brexit extension until October 31 does not extinguish the possibility that the MPC will raise Bank Rate before the end of the year," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics

Tombs, who has been rated by both Reuters and Bloomberg as the UK's number one economic forecaster, projects the UK economy will grow at an above-trend pace in the first quarter and says this will keep the Bank of England (BoE) under pressure to raise its interest rate before the year is out. 

The economy grew by 0.2% in February which, although down from 0.5% previously, was in line with market expectations. Taken together with January's result, Wednesday's number not only draws a line beneath the dire December 2018 month but also sets the economy on track for a solid first-quarter. 

Economic output rose by a total of 0.7% in the first two months of the year, which is even faster than the 0.6% pace of growth seen through the whole of the third quarter of  2018 and puts the economy on course for its best quarter since the period spanning April to July 2015.

Growth in February was broad-based, with only the agricultural sector seeing a decline in output. Services output grew by 0.2% during the recent monthg while industrial production rose by 0.6%. Manufacturing and construction production were up 0.9% and 0.4% respectively. 

 "We expect CPI inflation to be at or above the 2.0% target in all but two of the remaining months this year," Tombs says, in a note to clients. "In this light, investors look asleep at the wheel by pricing in no more than a 20% chance of the MPC raising Bank Rate this year."

An economic pick up in the first quarter could be enough for markets to begin taking the Bank of England a bit more seriously when it says that it wants to raise Bank Rate in order to safeguard the inflation target against a challenge from the consumer price index. Rising and sustained economic growth encourages inflation. 

The bank has said exactly that on repeated occasions in recent months but financial markets are yet to begin betting on rate hikes coming any time soon. The overnight-index-swap-implied Bank Rate for December 19, 2019 was just 0.74% on Friday, beneath the current 0.75%.

BoE officials have also suggested strongly that it won't risk clobbering the economy with higher interest rates if a so-called no deal Brexit looks likely at any point. That is why the two extensions of the Article 50 window have undermined the outlook for Pound Sterling. 

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