Declines in the Pound Likely to be Temporary say Soc Gen

As Pound Sterling embarks on another sharp move lower we are told that declines a new bold depreciation in the currency is unlikely

• Pound to Euro exchange rate today (October 26, 2016): 1.1170
• Euro to Pound Sterling exchange rate today: 0.8952

The Pound has dipped below 1.12 against the Euro and below 1.22 againt the US Dollar at the time of writing.

The declines are politically inspired and those with an interest in the currency will be wondering whether we are on the brink of another sharp move lower.

While some would say yes, others argue that the worst has passed.

“A fast and imminent continuation of the bearish trend at this stage is unlikely because a lot of UK bearishness is already priced in the exchange rate,” says analyst Olivier Korber at Societe Generale.

“The technical picture suggests a new turbulent range between 1.21 and 1.28, with a real risk to see short-lived spikes in liquidity air pockets below 1.20,” says Korber.

Importantly, we believe any relative stability in GBP/USD should be reflected in GBP/EUR and would therefore read between the lines and say the longer-term depreciation against the Euro is also nearing its end.

It is this ability to recover from falls below 1.20 that Korber believes will allow traders a new opportunity to profit on Sterling by buying the dips.

However, the analyst does caution that if 1.20 is crossed, it is presumably impossible to say where the bottom will be (algorithms exacerbate such moves while liquidity could not cushion a large acceleration).

Research from Societe Generale reveals that weekly ranges in GBP/USD exceeded most of the time 200 pips, so that a move a few figures lower is not that significant on a multi-month scale.

“The cable will shortly hit 1.18 if it returns below 1.20,” says Korber.

The important takeaway though is that the dips will be brief in nature.

A near-term appreciation in the Pound could still be expected as the market cleans extreme GBP shorts and adjusts the overshoot below interest rates:

As can be seen the Pound has decoupled from interest rate spreads, and it is assumed that the gap must close; which implies a degree of upside for the currency.

The Pound has been driven tightly by short-term interest rates for years, but decoupled only during the second collapse.

“If correlations still hold, it suggests a possible normalisation with GBP catching up higher after its overshoot. On the other hand, a massive GBP rebound also seems unlikely from there and at this stage,” says Korber.

However, while the discounted gloomy UK outlook prevents a new bold depreciation it also prevents a much stronger currency.

Korber notes that from a structural perspective the UK current account remains abyssal and more contextually, some hints of a Brexit effect on the real economy are appearing with the labour data released last week.

"Therefore, the GBP/USD should settle at a new equilibrium, where the gloomy fundamental outlook prevents both a new bold depreciation (already priced) and a bounce from there (justified weakness)," says Korber.

Latest Pound / US Dollar Exchange Rates

	Live: 1.3372▼ -0.11% 12 Month Best: 1.3789
*Your Bank's Retail Rate	1.2917 - 1.2971
**Independent Specialist	1.3185 - 1.3238 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Consolidation

Note that Sterling is starting to trade in tighter ranges against both the Euro and Dollar.

In the past such action has has proceeded a big break-out move, however the timing of such moves is notoriously tricky.

We observe that GBP/USD is staying close to the 20 and 50-hour moving averages on the hourly charts - confirmation of consolidation.

It is also refusing to fall below the 100-hour moving average which hints at a useful level of support.

Based on this we would expect further advances but remind readers to remain tuned to news headlines from the Government pertaining to Brexit.

Theresa May remains a key source of volatility on this front.

There were jitters in the exchange rate on Monday the 24th when May told Parliament that she would seek full sovereignty at impending Brexit negotiations.

Some in the market saw this as her repeating the mantra that sovereignty superseded fighting for full access to the EU single market.

However, the Pound soon recovered when May gave the following response to accusations from an opposition lawmaker that she was seeking a hard-Brexit:

"He talks about the hard Brexit that the government is going to take this country into. There is no suggestion of that whatsoever.

"(He) seems to think that all of these matters are binary decisions between either you are able to control immigration or you have some sort of decent trade arrangements, that is not the case.

"We are going to be ambitious for what we obtain for the United Kingdom and that means a good trade deal as well as control of immigration.”