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Pound to Recover into Year-End Forecast Lloyds

Lloyds Bank

Image © Pound Sterling Live

- Negotiated Brexit still base-case assumption

- Sterling to recover above 1.10 vs. Eur0, go above 1.30 vs. Dollar

- But, confidence in call unusually low

Analysts at British high-street lender Lloyds Bank say markets are too pessimistic on Sterling and that a negotiated Brexit deal is still the most likely outcome to the current impasse in their view.

According to Lloyds Bank's latest suite of financial forecasts, while the outcome to the Brexit impasse is still extremely difficult to predict, "our base case is conditioned on a negotiated withdrawal agreement later this year," says the bank.

However, confidence in this view is low considering the array of potential Brexit outcomes ahead.

The call comes amidst a determined downtrend in the British Pound that has taken the currency's trade-weighted exchange rate to record lows and analysts warn that the current spell of weakness is not yet over.

Effective Exchange Rate

The trade-weighted exchange rate is a measure of Sterling's performance against a basket of currencies containing the UK's main trading partners, and is therefore heavily weighted towards moves in GBP/EUR and GBP/USD.

"Brexit overshadows the UK, with the outcome still extremely difficult to predict. Our base case is conditioned on a negotiated withdrawal agreement later this year. However, a wide range of scenarios are still possible and it is hard to be confident about how and when a resolution will be reached," says Lloyds.

The Pound lost about 8% of its value against the U.S. Dollar having fallen from 2019's highs around 1.32 in early May, down towards 1.2080 recorded on August 01. The exchange rate has since ticked higher to 1.2163 at the time of writing.

Against the Euro, Sterling has this week fallen to a 22-month low at 1.0810, after the new administration of Boris Johnson committed to a Brexit on October 31 "no ifs, no buts" and said they would only be prepared to talk to the EU were the Irish backstop to be dropped from any agreement.

According to betting markets, the implied probabilities of a 2019 General Election now stands at fresh highs at just above 60%.

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There is also now a +60% implied probability that the Conservatives would win the most seats.

Implied probability of 'no deal' exit this year meanwhile stands around 38%.

Rising probabilities of a General Election and 'no deal' Brexit tend to push Sterling lower, and were these odds to increase the currency would likely come under further pressure.

"Volatility in the Pound has risen, market participants are increasingly favouring further GBP weakness, and there is a higher implied chance of outsized moves (in either direction) in the currency pair," says Lloyds Bank. "Until the UK and EU come back to the negotiating table, an extended rally in the Pound would appear unlikely."

 

Pound Oversold

Despite Sterling's decline, there is a sense that much of the bad news might already be incorporated into the price of the Pound.

According to a Reuters poll of economists conducted from 2-7 August, the median chances of a 'no deal' Brexit occuring has risen to 35%, up from 30% given in July: this is the highest since Reuters began asking this question two years ago. The findings suggest Lloyds is by no means alone in expecting an amicable solution to the current Brexit impasse being found.

Forecasts in this poll ranged from as low as 15% to a high of 75%.

A strong majority of economists polled still think the two sides will eventually settle on a free-trade deal.

"Perhaps the current levels of pessimism are too high," says Lloyds Bank of the market's stance on Sterling.

Assuming their base case scenarios for the UK and global economy are borne out, analysts now expect the Bank of England to hike its policy rate by 25bp in August 2020.

Markets are currently seeing only a 15% chance the Pound-to-Dollar exchange rate recovers back above 1.30 in 2019.

"This looks a little low given that the path to Brexit remains unclear. We continue to believe that the UK will leave the EU in an orderly manner and in such a scenario we would expect the GBP to rally strongly to 1.29 by end-2019," says Lloyds Bank.

The exchange rate is forecast to be at 1.33 by the end of 2020.

Sterling should also rise against the Euro under the base-case assumption that the UK and EU will arrive at a negotiated exit.

Based on this assumption analysts forecast the Pound-to-Euro exchange rate to rise over their forecast horizon with 1.12 pencilled in for end-2019 and 1.14 for end-2020.

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