Beware ’Profound' British Pound Selling Ahead Against Euro and Dollar says Morgan Stanley's Redeker

Redeker Morgan Stanley exchange rate analysis

With foreign capital inflows into the UK expected to come under further pressure, the only way for Pound Sterling is down says one of the City's leading foreign exchange analysts.

Stay ‘short’ on British Pound say Morgan Stanley - which for those note familiar with trading parlance, being 'short' means be prepared for further declines.

“Despite the UK’s July BRC like-for-like sales remaining stable, we see GBP coming under profound selling pressure over the next few quarters,” says Hans Redeker, lead FX Strategist with Morgan Stanley in London

Redeker makes the call following the release of retail sales data from the BRC which showed a pick-up in July; however there are concerns that the value of retail sales has been driven higher by the rising cost of food prices.

The BRC data shines a light on how UK households are facing increased inflationary pressures which are in turn weighing on economic sentiment and activity. The trend has been confirmed by similar data from VISA while Barclaycard report consumer sentiment is at its lowest point since they began surveying the British public.

“GBP should be even weaker than the USD as UK political risks increase and economic growth moves towards the back end within the G10. Yesterday, it was credit card turnover data suggesting the high level of non-secured debt is now taking its toll on consumer spending,” says Redeker.

Furthermore, data on the UK’s housing sector - a popular destination for foreign investor money - has shown prices are stagnating.

The keenly-watched Halifax House Price Index gives a gauge of how the UK housing sector is doing and their early-August report shows a decent enough 2.1% annualised change, but house prices in the last three months (May-July) were 0.2% lower thank in the previous three months. This was the fourth successive quarterly fall; the first time this has happened since November 2012.

“House price inflation has come down to one of its lowest readings since 2010, with GBP weakness failing to inspire foreign buying interest,” says Redeker.

In short, we would typically expect a steady flow of foreign demand for UK property on the back of Sterling’s current value.

But it would appear confidence is also required to drive such decisions, which of course in turn push up the value of Sterling as foreigners convert their currency.

It could be that uncertainty related to Brexit is holding back such investment decisions, and it remains possible that this uncertainty applies to other UK assets, not just bricks and mortar.

“Obviously, Brexit-related uncertainties have not only weakened investment into machinery and equipment. The UK, once the bridgehead into the EU, no longer sees the strong investment inflows it used to enjoy ahead of last year’s Brexit vote,” says Redeker.

These flows would be a major source of support for the British Pound.

Accordingly, the Morgan Stanley analyst believes the country must now source alternative inflows to cover its foreign funding needs.

And, with 10-year real Gilt yield now at -1.8%, the bond market does not offer value.

“Equities may see some inflows into companies benefiting from GBP weakness, but most of the foreign funding needs may now be covered via money market flows,” says Redeker. “By nature, these flows are currency unhedged, suggesting these funds will only enter the UK if GBP appears attractive (low) enough.”

So - it could be that the Pound needs to go lower. This is certainly a theme we have been writing about ever since the Brexit vote in June 2016.

The UK imports less than it exports leaving it reliant on inflows of foreign capital. And the warning was that a notable fall in the value of Sterling would be required to attract capital flows once the UK left the EU.

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Watch Details of UK Position Papers on Brexit

Hammond view on Brexit

This premium demanded on assets priced in Sterling is largely because of the uncertainty stemming from Brexit.

Until the picture on the UK-EU relationship becomes clearer, most believe both domestic and inward investment decisions will be subdued which will in turn hold back UK economic activity.

More clarity on the UK's position are likely to be delivered soon with reports this week suggesting the UK government is set to publish key Brexit position papers on issues such as Northern Ireland and the customs union.

The position papers are a reaction to increasing criticism that the UK does not have a clear plan.

Morgan Stanley believe markets will be sensitive to the details of these reports and will try to evaluate how strong the backing for Chancellor Hammond's open Brexit view is in official government position papers.

A similar checklist applies for the upcoming September speech by PM Theresa May.

“GBPUSD near 1.33is a strategic sell while a break below 1.2930 would confirm that a corrective top has been traded, opening the door for impulsive weakness targeting levels below 1.20,” says Redeker.

Morgan Stanley have actually been quite constructive on Sterling over recent months arguing that a respite in selling pressure was likely.

However, the investment bank’s sentiment took a turn following the Bank of England’s inflation report in early August. “We believe it is time to turn GBP bearish,” Redeker told clients after the Bank of England hinted that no interest rate rises were imminent.  

Morgan Stanley are forecasting the Pound to Euro exchange rate at 1.0870 by the end of 2017, 1.0638 by the end of March 2018 through June 2017 ahead of a recovery towards 1.11 by the end of 2108.

The Pound to Dollar exchange rate is forecast at 1.28 by the end of 2017, 1.26 by end-March 2018, 1.23 by mid-2018, 1.24 by end-September 2018 where it should stay until the end of 2018.

However, as mentioned in the article analysts are concerned the rate could go even lower.

Markets Eye Mounting Geopolitical Risks

An escalation of verbal sabre rattling between the US and North Korea is seeing markets price in more risk aversion.

Traditional safe havens like the JPY and Gold traded well, while the AUD - which has already been under pressure recently and so far ignoring the very positive industrial metals prices - took most of the pain in G10.

"The real worry, obviously, is that this turns to brinkmanship and then the wrong choice of words forces unwanted action," says Robin Wilkin, an anlyst with Lloyds Bank.

US yields and equity markets recovering from range lows has provided some calm to the markets and seen the USD pare back a little too.

However, markets remain on tenterhooks in regards to geo-political risk, gold and JPY testament to this holding onto recent gains.

Meanwhile base metal and oil prices continue to work higher, but so far hasn't influenced commodity currencies.


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