A 'Cheap' Pound has Bumper Day as Brexit Worries Fade Away

Exchange rates

Pound Sterling broke above a key resistance level against the Euro and worked hard to move above an established base against the US Dollar ahead of a key inflation data release due out on Tuesday 14 February.

Analysts will be watching an ONS releaes at 09:30 that is expected to show UK inflation was at 1.9% in January.

Anything stronger than this should aid Sterling higher, but a disappointment could trigger a retracement in the UK currency.

Leading to the release foreign exchange analysts were left somewhat baffled as to why the British Pound was the best performing currency at the start of the new week.

The Pound to Dollar exchange rate edged to 1.2519, up 0.52% on a day-to-day basis on Monday February 13 before reaching 1.2545 during early London trade on February 14.

The Pound to Euro exchange rate was meanwhile at 1.1807, up by 0.62% on Monday ahead of a further rise to 1.1815. (Note, our first target level set out in our week-ahead forecast has now been met).

So what is the cause of the Pound's strong performance, and importantly, can we exect more?

“Sterling is out-performing on the session; there is little, obvious justification for the relative strength,” says Shaun Osborne, an analyst with Scotiabank. “No data, no Brexit news beyond last week’s rapid passage of the Brexit bill through the Commons”.

Nevertheless, Osborne believes the Pound is looking “cheap” from a longer-term point of view, and thinks the exchange rate’s persistent weakness might have a lot to do with the to the Article 50 trigger nearing.

“We would prefer to look for opportunities to buy GBP dips on some of the more 'stretched' crosses,” says Osborne.

Such crosses where Sterling could outperform on such a basis in Osborne's opinion are GBP/CAD and GBP/EUR.

Despite strength seen at the start of the week it is worth pointing out that the exchange rate remains well within recent levels.

“Gains through the low 1.25 area may extend on a clear move above 1.2540 towards 1.2580 but perhaps no more for now. Trend strength oscillators are flat on the shorter-term studies, suggesting no real strength behind GBP gains for now,” says Osborne.

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It is also important to realise that the Pound is likely to benefit as the whole Brexit story fades.

We have a few weeks until the Article 50 clause of the Lisbon Treaty is triggered by the UK, which will start the process of the country's exit from the European Union.

There is actually very little to move markets in this regard now, if anything attitudes towards Brexit by markets have moderated from being all-out negative as was the case in 2016.

"The really big point is that far from being a tumultuous, cacophonic, unstable, firecracker of a polity, Brexit Britain is starting to feel like a relative island of calm, more at ease with itself than it has been for many years, led by a sort of 1950s Prime Minister, who is nearly 20 points ahead in the polls," says George Trefgarne, founder of Boscobel & Partners.

Trefgarne notes the spotlight of worry has swivelled round elsewhere, to Greece, France and to the United States.

"If Brexit is a revolution, it is so far turning out to be a very British and incremental one, lacking in violence or upset,” says Trefgarne.

The Return of Dollar Strength as the Trump Trade Looks to Fire Up Again

The Pound has done well to defend itself against the larger Greenback which has been ticking higher against most major competitors since President Donald Trump said he was looking to announce some tax changes in coming weeks.

This has markets betting that the reflationary ‘Trump Trade’ is not done yet and could well spark further US Dollar gains.

"USD buying particularly among leveraged investors has emerged after six weeks of selling. 'Buy USD' is also a signal that our algorithm holds (now in the 2nd day). This indicates to us the sensitivity of markets to positive news on tax reform," says Richard Cochinos at CitiFX.

Since the start of the year, the USD gave back some ground amid concerns of the Trump’s administration’s ability to implement aggressive fiscal spending plans.

“As expansionary fiscal policies come back in focus, they will leverage the existing acceleration of US growth even if, as we expect, only a third of the planned programme is implemented,” say analysts at BNP Paribas pointing to a pro-growth outlook under Trump.

Markets have been also focused lately on potential trade policies such as the implementation of a border adjustment tax, which analysts argue could raise the long-term equilibrium (FEER) value of the USD.

“We maintain our view that risk reward for USD longs has improved considerably,” say BNP Paribas.

BNP Paribas Positioning Analysis indicates that the market is currently short USD, down from +22 in the beginning of this year. Therefore, there is a lot of room for new long positions to be added.

So while the Pound is arguably undervalued it does remain subject to Brexit-related uncertainty which leaves it exposed to any major push higher by the broader US Dollar.

Euro Faces Further Under Pressure

With Brexit taking a back seat at the moment it would seem markets are content with shifting focus to where the next potential risks lie.

The Euro has been under pressure as Greek debt fears revive, and the French election edges more into the market's focus.

Greece's creditors have agreed on a common approach to demand yet more austerity. Athens has been given until February 20 to complete the second bailout review.

"The political risk calendar is starting to turn hot. The worst of these are unlikely to materialise, but the path ahead remains uncertain. With these risks starting to creep into debt market pricing, we think there may be limits on how long FX can ignore these concerns," says Ned Rumpeltin at TD Securities in London in a note to clients released at the start of the new week.

TD Securities are looking to sell the Euro on rallies against the Dollar, which in turn could allow the Pound to ride the Dollar's coat-tails higher.

"While the EUR has been a frustrating trade for USD bulls, we think current conditions favour a return of downside momentum. With Eurozone data surprises losing momentum, the ECB’s dovish stance may take on a greater urgency among investors," says Rumpeltin.

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