The sharp October selloff in Pound Sterling leaves the currency oversold and we could see a recovery over coming weeks argue Nordea Markets and BNP Paribas.
- Pound to Euro exchange rate: 1 GBP = 1.1368 EUR, best retail rate quote = 1.1250, worst retail quote = 1.0781.
- Euro to Pound exchange rate: 1 EUR = 0.8795 GBP, best retail quote = 0.8715, worst retail quote = 0.8341.
- Pound to Dollar exchange rate: 1 GBP = 1.2716 USD, best retail quote = 1.2602, worst retail quote = 1.2060.
October has woken currency markets from a multi-week slumber and we now see Sterling trade near a fresh 31-year low against the US Dollar having gone sub-1.27.
We have also seen EUR/GBP trade above 0.88 for the first time since the first quarter of 2013.
Looking ahead we ask whether the sell-off is ending or whether it is just getting oiled?
UBS argue that selling against the Euro will end towards parity, their argument can be found here.
However, other analysts believe it is now time for a recovery to shape up.
The muscular October sell-off in Pound Sterling following Theresa May's announcement of a deadline in March 2017 for triggering Article 50, is unwarranted says Nordea Bank’s Aurelija Augulyte.
“UK PM Therese May in the annual Conservative conference effectively said that the Article 50 will be triggered by the end of March next year. We don’t think this is news nor a sufficient reason to panic – the UK data and policy decisions will be drivers in the near term,” comments Augulyte in a recent note to clients.
This somewhat goes against the grain of most of the analyst community who expect further weakness from the Pound.
Augulyte argues that the shock to the economy since Brexit has been largely confined to ‘confidence’ since manufacturing and industrial data, have largely recovered.
She puts this down to the impact of weak Sterling which has made UK exports more affordable.
This is likely to keep data positive in the months to come, reducing the chances of the Bank of England increasing monetary stimulus, a move which would be widely seen as negative for the Pound.
In the September BoE statement, the Bank said “a majority of members expect to support a further cut in Bank Rate…” and that future action will be data dependent.
The data have surprised to the upside so far.
"Nonetheless, markets are pricing additional BoE easing: a rate cut of some 5-6bp is still in the market price for this year. However, the risk is that the BoE will not dare, or if so, changes will be cosmetic,” argues Augulyte.
In addition to the weak Pound, the economy may also be supported by the monetary and fiscal stimulus policies already enacted.
This has included the 0.25% interest rate cut and 50bn per month QE programme from the BOE, and the new Chancellor Philip Hammond’s decision to drop the previous administration's promise to balance the budget by 2020.
These moves are likely to be stimulating for the economy and lead to improved data in the months to come, which could further lessen the chances of the BoE expanding stimulus measures.
There is always a lag between the time interest rate cuts are enacted and when they start to have a stimulatory impact on the economy.
Augulyte also suggests the BoE may withhold a rate cut in order to help preserve bank profitability given concerns globally about the banking system.
Although the net consensus is that GBP will end the year at 1.2700, Nordea’s Augulyte thinks that is too bearish and for the reasons given above she thinks it is more likely to rise instead to 1.32.
The GBP/USD is also noted as being undervalued.
"The market is still very negative on the GBP. The speculative market positions remain stretched to historical extremes: net speculative shorts are nearly 2 standard deviations above the historical mean.
"The GBP is already undervalued by most long-term measures; the PPP suggests the GBP/USD cross is some 10% too low relative to fair value."
BNP Paribas See Sterling Bottoming, Recovering to 1.37 vs US Dollar in 2017
It's not just Nordea who believe the recent sell-off is overbaked.
The Pound’s decline is now almost done, argues BNP Paribas FX analyst Sam Lynton-Brown in a recent note:
"In our view, the bulk of the GBP’s post-Brexit decline has now taken place.
“The GBP has now fallen to very low levels both historically and according to valuation metrics, which likely represents an attractive entry point for long-term GBP buyers.”
Lynton-Brown goes against the grain in forecasting cable at 1.37 by the end of 2017, which infers a massive recovery from present levels during the next year.
Nevertheless, he admits that there is a strong possibility of further weakness in the short-term:
“That said, in the near term the GBP is likely to remain weak, and may even fall further in the short term due to heightened economic uncertainty, Bank of England (BoE) easing and a softening growth outlook – our end of year GBP/USD forecast is 1.28.”
In the short-term, the UK economy is likely to find itself in a challenging environment.
Growth may drag and Lynton-Brown expects the BoE to cut interest rates again to 0.1% (from 0.25% presently) and to increase QE by a further 50bn in February.
However, these short-term challenges need to be set against the enormous divergence setting up between the real exchange rate and the exchange rate generated from BMP Paribas’ models.
“Our medium-term CLEER™ model signals that the Brexit vote pushed the fair value for GBP/USD from 1.50 to 1.35 (assuming a broad basic BoP deterioration to -10%).
“Longer-term, our FEER calculation stands at 1.64, with the lower bound of the valuation range at 1.41. By these valuation measures, the GBP appears very cheap at current levels,” says the analyst.
Clearly, according to these models the pair is highly undervalued and due to reversion to a level closer to ‘fair value’.