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Pound Sterling Outlook: Goldman Sachs Drop Bullish Stance on Pound-Euro Rate

Goldman Sachs

FILE PHOTO - A view of the Goldman Sachs stall on the floor of the New York Stock Exchange. REUTERS/Brendan McDermid/File Photo

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Strategists at Goldman Sachs are no longer holding a bullish stance on the British Pound, saying they need to take a step back and reassess their views on the currency in the wake of a disappointing reaction to the signing of the EU-UK trade deal in late December.

The Wall Street bank had been buyers of Sterling and sellers of the Euro, targeting move to 1.15 in the Pound-to-Euro exchange rate (a decline to 0.87 in EUR-GBP) on the assumption the UK currency would benefit from the signing of the deal on December 24.

Sterling's reaction to the free trade agreement has been distinctly lacklustre and the Pound-Euro rate has fallen back from 1.1182 on December 31 to 1.1017 at the time of writing, defying a consensus expectation for a modest rally in valuation.

"We are closing our trade recommendation to go short EUR/GBP at a small potential profit, but well short of our initial 0.87 target, which we had thought could be achieved once the UK and EU secured a post-Brexit trade agreement," says Zach Pandl, an economist with Goldman Sachs.

Pandl says the initial market reactions to Brexit developments were in line with our expectations, but it appears that further appreciation pressure was stymied at least in part by resurgent Covid risks.

GBP to EUR since Brexit agreement

Above: GBP/EUR price action since the EU-UK trade deal was agreed.

Last week saw another lockdown implemented in England and Scotland, a move that has lead economists to slash their forecasts for the UK's economic output for the first quarter of the year.

But the medium-term remains constructive for the UK economy, according to Goldman Sachs economists who "remain confident" that the UK will ultimately be well-placed to benefit from prolific vaccine distribution.

This should lead to a rebound in the country's significant service sector, which will continue to find support from the government's fiscal support schemes as well as that from the Bank of England.

"But it is also true that the Brexit deal is relatively narrow in scope and activity will continue to face a number of headwinds over the coming months. As a result, and with the main catalyst now behind us, we are taking a step back to reassess our Sterling views for the post-Brexit world," says Pandl.

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The Pound-Euro rate has pivoted around the 1.11 for months now, forays higher or lower from this point tend to fizzle out, with the exchange rate retracing any significant moves.

In short, the market has become quite predictable - despite the momentous signing of a EU-UK trade deal on Dec. 24 - and is awaiting a new fundamental driver.

"We continue to expect GBP to underperform in a G10 context," says Dominic Bunning, Head of European FX Research at HSBC.

There is a strong theme emerging amongst foreign exchange analysts the suggests the Pound will see a subdued start to 2021 as the UK battles with an aggressive resurgence in Covid-19, shuttering large parts of the economy in its efforts to stem the spread of the virus.

These actions have in turned knocked economic growth lower and economists are now saying the country is enduring its second recession in a year.

The prospect for the Bank of England to respond by cutting interest rates has risen accordingly, a repricing that has acted as a headwind for Sterling appreciation.

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However, the UK Government is currently engaged in an ambitious vaccination project and seeks to have the most vulnerable injected with their first vaccination by mid-February.

This could ease pressure on the medical service and in turn allow for a more sustainable reopening of the economy, making for a more constructive 2021.

"We expect that the political turmoil around the negative impact of Brexit and lockdowns will subside fairly rapidly with the emergence of widespread vaccinations and rising global growth," says Thomas Flury, Strategist with UBS Switzerland AG.

Flury says that as confidence in the global economic recovery grows, the attractions of the Pound will become more apparent.

"For instance, we think the recent rally of the pound signals that sterling is - and remains - an attractive diversification currency, one which rises along with the euro whenever investors want to unwind USD holdings," says Flury.

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