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Nordea Markets: Five Reasons to Bet on the British Pound against the Euro and US Dollar

 

uk gdp growth 1

Almost on cue with the latest research report from Nordea Markets we see Pound Sterling rising. Why does analyst Aurelija Augulyte believe the time is nigh for a recovery in the UK currency?

  • Pound to Euro exchange rate today (2-11-16): 1.1110
  • Pound to Dollar exchange rate today: 1.2320
  • Euro to Pound Sterling exchange rate today: 0.9001

The Pound trades at a two-week best against the US Dollar having risen back above 1.23 and against the Euro we have seen the UK currency once again successfully defend the floor at 1.1078.

There is a sense that pressures on the Pound are easing and the debate between analysts as to whether the base will resolve into another move lower, or a more sustained recovery rages on.

Nordea Bank’s Aurelija Augulyte is one of those strategists who believes the UK currency is now actually due a rebound.

In a research note to clients Agulyte forecasts more upside for Sterling versus the Dollar and the Euro citing five reasons:

1. Markets not Accounting for Better-than-Forecast Growth

Economic research has been flat-ignored of late.

Q3 GDP came out much higher than forecast at 0.5% - easily beating the consensus estimate of 0.1%.

Yet the Pound trades at multi-year lows agianst the Euro and Dollar.

Agulyete believes the Bank of England (BoE) was overly pessimistic at its September meeting when the majority of BoE officials were in favour of further cuts.

“In the September BoE statement, it said that 'a majority of members expect to support a further cut in Bank Rate…', but the data so far proved the BoE too pessimistic,” said the Strategist.

Because of the much stronger growth outlook, the BoE is expected to drop the sentence about the "majority of the BoE wanting to cut rates" from the November statement, which as we note here, could well support Sterling.

Latest Pound/Euro Exchange Rates

United-Kingdom European-sUnion
Live:

1.1123▲ + 0.02%

12 Month Best:

1.208

*Your Bank's Retail Rate

 

1.0745 - 1.079

**Independent Specialist

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

2. Survey Data

It's not just official data that has outperformed, survey data has also been positive and indicates that UK economic growth should remain robust through early 2017.

“We have seen PMIs surprising a couple of months in a row. The industrial and export data should broadly improve further, largely due to the past GBP weakness,” adds Agulyete.

3. Recovery in Housing

Housing data was hit hard by the news of Brexit just after the referendum, however, that too has rebounded.

“The Brexit shock was seen primarily in housing data, but even the housing market indicators have improved a bit in the most recent readings.

“The uptick in mortgage applications and the RICS survey, for example, show that the housing market is not coming off the rails just yet and the downturn may be shallower than first thought,” commented the Nordea Strategist.

We note however that October's Nationwide data shows house price growth slowed to 4.6% from 5.3% in September; nevertheless this is still growth that will keep many first-time buyers off the property ladder for some time yet.

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4. The BoE are Conscious of Pound's Weakness

The BoE are now less unlikely to introduce policies which could lead to a weaker Pound.

A weaker Pound has already started to increase inflation by making foreign imports more expensive, however, the Bank will not want this to get worse as it drastically reduces the buying power of people's wages.

This does not just decrease consumption and cause hardship but also has a negative knock-on effect on debt markets, as people start to struggle to make loan repayments, and this, in turn, can begin to undermine the financial system. 

BoE Governor Carney has already said in testimony to the Treasury Select Committee that he is not indifferent to Sterling’s weakening and the BOE will not look through the pass-through effects on inflation.

He indicated they will take note of Sterling in their decision-making, suggesting they will steer clear of policies which will drastically weaken the pound further.

This suggests less easing.

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"The effective GBP exchange rate is some 7% weaker than the BoE projected in its inflation report. Using the rule of thumb, a 7% weakening of the GBP, if sustained, should add more than 1.5% points to inflation in the next two to three years. This adds to the already high inflation prospect," says Augulyte.

5. The Pound is Grossly Below Estimates of 'Fair Value'

Agulyte states that GBP has weakened 7% against a basket of currencies since Brexit and that this translates to a full 1.5% rise in inflation over the next two to three years, which “adds to the already high inflation prospect.”

That the Pound is likely to rise for other reasons too, is also noted by Nordea’s Strategist.

For example, she states that Sterling has deviated markedly from the usual models of value.

Interest rate spreads - which is the difference between the UK and US interest rates -  have shown a dislocation from the GBP/USD exchange rate which is unusually wide.

Normally the interest rate difference correlates with the exchange rate in line with investors' preference for higher yielding currencies, however, the current dislocation is showing the Pound as 10% undervalued.

“By long-term models, the GBP is at least 10% undervalued against the USD and the EUR (especially against the USD).,” she notes.

This suggests Sterling is due a ‘snap back’ higher in line with the usual close correlation.

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"We are thus a bit more positive than the consensus and still see GBP/USD and EUR/GBP at 1.26 and 0.87, respectively, by the end of the year," says Augulyte.

EUR/GBP at 0.87 = GBP/EUR at 1.1494.

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