Deutsche Bank Turn Bearish on Pound Sterling, Prefer the Euro

- Deutsche Bank say GBP set to turn
- New variants could undermine GBP
- Say sell GBP, buy EUR

Turning bearish on the British Pound

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"Having been vocal GBP bulls at the start of the year we are now turning bearish," say foreign exchange analysts at Deutsche Bank.

The bank - one of the largest dealers of foreign exchange in the world - have said in a new strategy brief that while "the stars have aligned so far this year for sterling" "a lot of good news is in the price".

The call, if correct, could serve as a warning to those market participants sitting on the sidelines and expecting a continuation of recent advances in the Pound. 

But it is not just a belief that the good run has run out of steam that drives this shift in view, analysts also believe the Bank of England will disappoint markets with the timing of the first interest rate hike.

In addition, the 2021 economic rebound might underwhelm owing to new variants of Covid-19 and the potential for a disappointing consumer-lead rebound.

As such, Deutsche Bank recommend selling the British Pound against the Euro and the Swedish Krona.

DB sterling 1

"The stars have aligned so far this year for sterling. A strong vaccination rollout, rates repricing, positive data surprises, rallying stocks and strong FDI inflows have all helped the pound to its strongest start to a year since 2014. We think a lot of good news is in the price, however, and that there are better European currencies to own," says Deutsche Bank Strategist George Saravelos in London.

The Pound was one of the better performing currencies in the first quarter of 2021 but it did struggle in April and returned a good portion of its earlier gains.

May has since seen the Pound recover somewhat and some analysts are confident that the trends of early-2021 are reasserting.

"We remain bullish on GBP, as we are still more upbeat on the UK than on the euro area," says Mikael Olai Milhøj, Chief Analyst with Danske Bank.

DB Pound Sterling 2

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One of the drivers of the May recovery seen in some Pound exchange rates was the May 06 Bank of England policy event where policy makers announced they would reduce the scale of quantitative easing they would conduct on a monthly basis.

The Pound-to-Euro exchange rate dropped to lows around 1.1460 in April before recovering back to a high of 1.1680 in May following the Bank of England decision.

Meanwhile the Pound-to-Dollar exchange rate has recovered from April lows close to 1.36 back to recent highs above 1.42.

Markets interpreted the move by the Bank as a sign it was stepping back from offering generous support to the economy in a crucial first step towards raising interest rates again.

The Pound tends to find support when the Bank of England moves towards raising interest rates, and the closer this 'lift off' date is brought forward the more support it finds.

But Saravelos says the market could be found guilty of being too optimistic on this count.

"The rates market is now pricing a rate hike by next September but this looks rich given the UK is still projected to have the largest negative output gap in G10," says Saravelos.

DB pound sterling 3

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One of the pillars of the flip to a bearish stance on Sterling by Deutsche Bank is the view that a new Covid-19 variant could emerge and derail the country's reopening process.

After all, it was the successful vaccine rollout that has allowed economists to raise their forecasts for economic growth and bet the Bank of England would find itself in a position to raise interest rates once more.

The emergence of the Indian variant (B.1.617.2) in some parts of the UK have been cited as a reason by Deutsche Bank to caution that the UK's road out of lockdown won't be smooth, disrupting the bullish case for the Pound.

"On the vaccine front, the most likely outcome is that the economy will fully reopen from late June, but given current pricing the risks are asymmetrically to the downside given increasing concern over new variants (B.1.617.2 variant in particular)," says Shreyas Gopal, an analyst with Deutsche Bank.

However, we have noted that other economists are of the view that the variant is unlikely to blow the UK's reopening off course and that the bar to a reversal of lockdowns is high, given that the variant is spreading in a country with a high inoculation rate.

"At the current growth rate, it would take another 30 weeks for cases to reach the level in early November, which persuaded the government to impose the second lockdown," says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.

Another large pillar of the 2021 UK rebound story resides with an assumption made by economists that consumers would spend pent-up savings when restrictions are eased, prompting an economic boom.

But evidence from Israel suggests to Deutsche Bank that consumption may be quicker to fall back to its new steady-state than expected, which could have implications for the rebound if the same behaviour translates to the UK.

DB Pound Sterling 4

Meanwhile, flows that have favoured the Pound thus far in 2021 might also have peaked.

"The post-Brexit rebound in M&A flows have been another supportive driver of sterling so far, along with asset managers reallocating into GBP per our own internal FX flow metrics. Both these flows seem to have peaked," says Gopal.

"All up, it's been a good run for sterling so far this year, but the baton for the summer is likely to be handed to the rest of Europe. We like buying EURGBP, with the cross also likely to rally if our bearish house view on equities is realised," he adds.