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British Pound Can Fall Another 4%: MUFG

Conservative Party leader front-runner Boris Johnson. File image © Foreign and Commonwealth Office, Reproduced Under CC Licensing

- MUFG eyes 4% decline on unfavourable Brexit headlines.

- But Pantheon sees losses as harbinger action from BoE.

- Pantheon eye GBP gains Vs USD and EUR before year-end.

Pound Sterling trades under fresh pressure at the start of a new week, with losses ensuring the currency remains within touching distance of multi-month lows against the Euro, Dollar and other major currencies.

There is no specific news triggers to the losses on Monday, rather negative momentum remains entrenched with markets eyeing a cocktail of political risks and a weakening economy as resons to hold a negative bias on the UK currency.

The GBP/EUR exchange rate is quoted at 1.1116, down over 0.30% on the day's opening level, while the GBP/USD exchange rate is quoted at 1.2513, down 0.45% on the day.

The trend is certainly strong: last week saw Sterling record a record tenth consecutive week of declines against the Euro, and we are told it could yet fall another four percent over coming months if the outcome of the ongoing Conservative Party leadership election leads to adverse Brexit headlines.

According to MUFG, the world's fifth largest bank and a significant currency dealer, says the market could increasingly perceive that a 'no deal' Brexit is becoming more likely over the coming weeks and months, which is likely to ensure that Pound Sterling remains under pressure against the Dollar and Euro. 

The result of the ongoing Conservative Party leadership election, which is expected to be announced on July 22, will be a milestone in the Brexit process only the ballot of grassroots members is expected to install former foreign secretary Boris Johnson in 10 Downing Street. 

"A weaker Pound remains one of the clearest trends in the FX market. EUR/GBP is on course to increase for the tenth consecutive week," writes MUFG's Lee Hardman, in a research note posted this week. "There is a high risk that discussions with the EU could break down without significant changes to the backstop...Boris Johnson could find himself under pressure to honour his pledge to leave the EU by the 31st October without a deal." 

Above: Pound Sterling performance Vs G10 rivals over the course of the past month. Source: Pound Sterling Live.

Johnson has committed to leaving the EU at the end of the Article 50 extension period whatever the weather in Westminster and Brussels on October 31. He says he wants to renegotiate aspects of the three-times-rejected EU Withdrawal Agreement, which the EU says it won't do, but that he'll leave through a 'no deal' Brexit if necessary. 

The opposition Labour Party and some MPs within the Conservative Party have repeatedly threatened a vote of no confidence in the government if it pursues a 'no deal' exit, which would give way to a period where other parties attempt to form a coalition and in the event they fail, a general election.

However, Boris Johnson has refused to rule out suspending parliament in an effort to circumvent a no confidence vote, which Chancellor Philip Hammond recently described as the only way in which rebels on the government benches could be prevented from helping to bring down their own government.

"It is difficult to see a clear trigger which could bring an end to the current weakening trend. We expect the Pound to continue weakening heading into the crunch autumn Brexit period," Harman says. "There is still scope for speculative short pound positions to increase further which could reinforce downward momentum. After breaking below the 1.2500-level, the door has been opened for cable to potentially retest the lows from late 2016/ early 2017 at around the 1.2000-level," says Hardman.

Above: Pound-to-Dollar rate shown at daily intervals.

Hardman has warned clients of a four percent loss for Sterling relative to the Dollar before the autumn because of the likely increase of fears about a 'no deal' Brexit, although he also says the Pound's losses would be much more severe if such a scenario were actually to play out. MUFG forecasts the Pound-to-Dollar rate will fall to 1.10 and the Pound-to-Euro rate will drop to parity in the event of the UK leaves without a deal.

Others agree: "GBP is clearly vulnerable against a backdrop of political uncertainty and a deteriorating UK economic environment," says Jane Foley, a foreign exchange strategist with Rabobank. "The Brexit outcome and politics developments remain the largest driving factor for GBP."

Rabobank are forecasting the GBP/EUR exchange rate to be at 1.11 in three months, but a resolution to the ongoing chronic political uncertainty should see Sterling to recover with the exchange rate forecast at 1.16 in six months.

Another analyst tells us that any further losses by Sterling could trigger higher interest rates at the Bank of England which could in turn ultimately support the Pound and therefore provide support over the longer-term.

According to Pantheon Macroeconomics' chief UK economist Samuel Tombs, inflation is now in danger of rising back above the 2% target and remaining there in the years ahead, in part owing to a falling Pound. 

"Sterling is 4% below the level anticipated by the MPC in May’s Inflation Report, implying a 0.3% uplift to CPI inflation in two years’ time and a 1.1% long-term uplift to the MPC’s expected path for the price level," says Tombs, who has been rated by Bloomberg and Reuters as the nation's top inflation forecaster. "The MPC likely is less willing now than back in 2016/17 to tolerate above-target inflation. The MPC will be more fearful that the rise in inflation will become embedded through higher wage growth."

UK inflation was 1.9% in May 2019, down from 2% the previous month, although it has spent much of the time since the Brexit referendum above the target because of the resulting falls in the Pound which made imported goods more expensive to buy.

Tombs says the latest inflationary falls in Sterling are unlikely to sit well with the Bank of England.

BoE policymakers have said repeatedly in since the referendum they think UK rates will need to rise in the coming years to keep inflation in check. 

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

It's only the sheer uncertainty about the likely outcome of the Brexit process, which will dictate the economic outlook for the years ahead, that's kept the Bank from raising borrowing costs for companies and households ever since lifted Bank Rate to 0.75% in August 2018.

But Tombs is forecasting that regardless of who wins the Conservative leadership election this month, the UK will likely request a further extension of the Article 50 period beyond the current deadline of October 31. 

Changes in rates are normally made in relation to the outlook for inflation, which is sensitive to economic growth, but impact currencies because of the influence they have over capital flows and the decisions of short-term speculators. Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.

"We continue to expect the Committee to disappoint markets' hopes of more stimulus. This time, another period of above-target inflation would run a very real risk of de-anchoring inflation expectations. If, as we expect, politicians once again push back the Brexit deadline in the autumn, the spotlight will return quickly to rate hikes," Tombs writes, to clients this week. 

Tombs and the Pantheon team forecast the Pound-to-Dollar rate will finish 2019 at 1.32 and that the Pound-to-Euro rate will close the year at 1.18.

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