British Pound Forecasts Slashed as Brexit Risks Crystalise
Credit Suisse take the knife to their pound sterling forecasts for 2016 citing three major risk factors.
Esteemed Swiss lender Credit Suisse have revised down their three and 12-month forecasts for the pound by -5.8% and -8.2% respectively versus the dollar, and -10.0% and -8.7% respectively against the euro.
The sharp revisions come as a result of increased concerns about the impact of Brexit, now that there is increased likelihood of a referendum in 2016.
“We have long worried about the question of how the GBP would react to a likely Brexit referendum in 2016.
“Our previous work had suggested that the market usually tries to price event risk of this type around 6 months before the actual event takes place.
“With an actual referendum date still unknown, we had resisted trying to short the GBP in our model portfolios until more clarity emerged.
“There was also still some probability that the market would support GBP for a little bit longer as a form of "European USD" given there was at least a marginal chance of a rate hike in the UK in 2016, unlike the rest of Europe."
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Three Reasons Why 2016 Will not be Kind to Sterling
However, the report goes on to say that matters have now led them to “come off the fence,” mainly as a result of poor data pushing back BOE rate hike hopes into 2017, but also as a result of international developments:
“Meanwhile, the ongoing problems in EM space and China in particular has further raised the odds that not only will money no longer be available from that source to fund the UK's 5% of GDP current account deficit, these players may actually end up being forced sellers of GBP assets as they try to replenish more valuable USD holdings.”
The triple-whammy of a slow-down in emerging markets, a Europe which has still not ‘taken the bandages off’ and the risk of a referendum are all weighing:
“The UK seems to be paying a price for choosing to hold a pivotal referendum in a year when emerging markets – a key source of funding – is under fire, even before its key trading partner the EU has recovered as an exports destination or source of income from assets invested there.”
The report uses a GBP implied volatility as a ratio of G10 volatility model, to estimate a most likely date band for a referendum, which is between June and September, although it argues that this underestimates the, “possibility that the February 18-19 EU Summit also causes issues.”
“What if the summit does not go as well as expected and the UK government cannot extract acceptable terms?” It questions.
Such a scenario, argues Credit Suisse could lay the foundations for higher volatility in Q1 as the 'out' vote might gain traction following a lack of agreement on a special deal for the U.K.
It could also suggest that not all the “bad news” on Brexit as already been priced in:
“Until this risk is also priced in, it's hard to argue convincingly that all the bad political news is now in the price for GBP. This would require a flatter GBP implied vol curve, driven by higher 1-2 month implied vol levels.”
Revised Pound Forecasts
The bank sees the possibility of the euro to pound exchange rate rising to 0.75 by January 2017, from a previous forecast of 0.69.
Its analysts expect the pound to depreciate even more sharply in the next 3 months – potentially hitting 0.77 to the euro - a 10% fall (in the pound) from their previous 0.70 forecast.
Turning the equation around his equates to a pound to euro exchange rate of 1.2887 in three months and 1.3333 in 12 months.
For cable the bank sees the potential for a touch of the 1.40 handle in the next 3-months from a previous expectation of 1.49, but revise their 12-month outlook to as low as 1.33 from 1.45 previously.
