British Pound to Extend Losses Against Euro and US Dollar as UK Interest Rate Yields are Forecast Yet Lower

Societe Generale forecast a second bout of Pound Sterling weekness over coming weeks with the GBP/USD bearing the brunt of the declines.

• Pound to Euro exchange rate today: 1.1733, best rate last week: 1.1784
• Euro to Pound Sterling exchange rate: 0.8527, best rate last week: 0.8657
• Pound to Dollar exchange rate today: 1.3134, best rate last week: 1.3273

Despite a strong showing over the course of the week ending 26th August, GBP is forecast to record further declines against the US Dollar over coming months, while also continuing to struggle against the EUR.

This is the view of Societe Generale who have updated clients with their latest views for Sterling, the Greenback and the single currency for the remainder of 2016 and through 2017.

Understanding why further losses are likely requires an understanding of why the UK currency outperformed in the week gone by.

Soc Gen, and many other analysts we have heard from, believe the rally in Sterling is technical in nature and being driven by the unwinding of heavy negative positioning by speculators and investors against the currency.

Following the EU referendum and subsequent gloomy economic forecasts, it is not hard to understand why the trading community is biased against the currency.

However, with market so one-directional, some 'house keeping' must be done to restor some kind of balance to the market. This requires some of those negative bets being closed out in what is known as a 'short-squeeze'.

A trigger for such a move would have been the better-than-forecast data we have seen of late which has gone some way in dispelling the gloomy economic forecasts we mentioned.

As can be seen, Soc Gen see the recent recovery being technical, and not necessarily fundamentally-driven:

But, it would be wrong to say fundamentals should be completely discounted.

Economic data releases suggest the UK economy has so far been resilient to any significant Brexit shock, data has shown:

• the fastest rise in consumer credit in a decade,
• more business lending,
• and export orders posting their best performance in two years.

However, Sterling remains the second-worst performing major currency out there having fallen by 12% in the year-to-date.

Only the Argentine Peso has performed worse.

Latest Pound/Euro Exchange Rates

	Live: 1.1449▲ + 0.05% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.106 - 1.1106
**Independent Specialist	1.1289 - 1.1335 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

But - Next Leg of British Pound Weakness Still to Come

“The pound fell further, faster than we expected, after the vote to leave the EU,” says
Kit Juckes at Societe Generale in london.

Soc Gen wrote ahead of that vote that they thought GBP/USD would fall to 1.30-1.35, as we know it touched 1.2796.

“The initial reaction seemed overdone, and it still does,” says Juckes.

However, Soc Gen also warned that a second wave of GBP selling would occur as the economic effects of long-term uncertainty became gradually clearer.

“From here, it seems to us that the risks are heavily skewed to the downside over any longer time horizon than a month or so,” says Juckes.

Pound to Track Interest Rate Differentials Lower

Foreign exchange valuations tend to track the difference in interest rates between two different countries.

The basic idea is money will flow into the country with higher rates as investors seek higher yields.

The Bank of England’s latest rate cut, and quantitative easing programme, have both conspired to push UK rates lower.  

You can see from the chart below that this is the story painted by the relative moves in rates and currencies:

“The currency is now back broadly in line with monetary policy, and general opinion is becoming more optimistic about the economic effects of leaving the EU,” says Juckes.

Soc Gen believe further declines in UK interest rate yields are likely as the Bank of England continues to succeed in pushing yields lower.

Indeed, many forecasters expect the Bank to cut rates again in November.

“The only organisation that is willing to push the boat out and act aggressively is the BoE. A further cut in rates would, at the very least, ensure that the US/UK rate gap doesn’t narrow, and would probably widen it further,” says Juckes.

Soc Gen can’t see sterling decoupling from those relative rates and thus still see plenty of downside once the initial sentiment that the economy is weathering the political storm well abates.

Dollar to Continue Higher

So while the GBP is expected to suffer further declines, the Dollar is meanwhile expected to gain in value.

Societe Generale’s view remains that the dollar uptrend is likely to re-establish itself before year-end as the market prices in a higher probability of Fed rate hikes next year, though they do not expect a Fed hike until 2Q 2017.

But the trend is also likely to be a weak one given the cautious Fed.

A good hint at the likely path for this debate was provided by Fed Chair Yellen on Friday 26th August when she delivered the opening remarks at the Jackson Hole Symposium. 

Yellen all but confirmed a rate rise would take place by December having noted:

"Based on this economic outlook, the FOMC continues to anticipate that gradual increases in the federal funds rate will be appropriate over time to achieve and sustain employment and inflation near our statutory objectives.

"Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months."

The full transcript of the speech can be found here.

The Dollar did not rally on the news but it does suggest a strong fundamental base exists for Soc Gen's pro-USD stance to materialise.

Soc Gen's GBP Forecasts for 2016 - 2017

The Pound to Euro exchange rate is forecast at 1.1628 by December ahead of 1.1764 in March 2017.

By June 2017 the exchange rate is expected to trade at 1.19.

The Pound to Dollar exchange rate is forecast at 1.26 by December, 1.23 by March 2017 and 1.25 by June 2017.

For a full list of G10 forecasts from the bank, please see here.

Yellen SparksDollar Surge, Then Drop

"The currency markets frequently live and die by the 'shoot first and ask questions later' motto. Today they were asking awkward questions just seconds after firing," notes David Lamb at FEXCO in comment to today's comments by Fed Chair Yellen that "the case has strengthened" for a rate rise in 2016.

Trigger-happy traders were snapping up Dollars in expectation of an near-immediate rate rise.

"But as the seconds ticked by, it became increasingly clear that a hike is inevitable, but not imminent.

"Cue a huge correction that saw the Dollar slump well below its pre-announcement levels – leaving many traders unable to see their terminals for the egg on their faces," says Lamb.

Lamb explains further:

"The caveats came thick and fast. There's a range of possible rate rise scenarios, they could still be blown of course, and the killer line – gradual hikes are appropriate.

"All of which has led the Dollar bulls to be corralled back up and the expectation to fizzle out. It's back to business as usual for Dollarwatchers, as the Greenback's prospects remain strong but not stellar.

"Yellen's speech left the market it little doubt - while the US economy is performing well, few now expect a rate hike in September, or even before the year is out."