-Another 5% upside to GBP/CHF say Societe Generale.
-Brexit transition means higher interest rates and Sterling.
-Call follows others by UBS and Bank of America Merrill Lynch.
© SlayStorm, Adobe Stock
Pound Sterling is set for even further gains over the Swiss Franc later this year, according to currency strategists at investment bank Societe Generale, which could see the exchange rate rise by another 5% from its current level.
The British currency has already notched up a 4.6% return against its Swiss counterpart during 2018 but the Societe Generale team are now eyeing another possible leap for the exchange rate, which could come due to a range of factors. They are not the first either as now-growing choir of strategists have previously advocated playing off the developed world's most undervalued currency against its most expensive.
However, despite this, the call by Societe Generale is significant because the foreign exchange team there have been among the more bearish in their outlook for the Pound ever since the Brexit referendum of June 2016. As recently as December 2017, the French banking firm forecast the Pound to fall as low as 1.02 against the Euro before the end of 2018 and 1.23 relative to the Swiss Franc.
"Improved UK growth prospects will have an impact on monetary policy and should support sterling, at least for now. There are still hurdles to overcome, but the chances of a smooth Brexit have improved, which would be supportive for growth and point to more monetary policy tightening than is currently expected," says Kit Juckes, chief FX strategist at Societe Generale. "That’s good for sterling, especially as it is still trading over 10% below its 25-year average in tradeweighted terms."
Above: Pound-to-Swiss-Franc rate shown at weekly intervals.
Sterling fell by close to 20% against the Dollar, 13% against the Euro and some 19% against the Swiss Franc after the vote to leave the European Union in June 2016, as traders marked down their long term interest rate expectations given the perceived damage wrought on the UK's short and long term growth prospects.
The actual economic fallout from the referendum has been strikingly benign thus far and with March having seen negotiators strike an agreement to preserve the status quo for 21 months after the UK is due to leave the EU in March 2019, markets have now become more sanguine about the perceived risks of Britain’s departure from the block of late.
"The Brexit referendum hit sterling hard, because it hit growth expectations. We believe a softer [Brexit] will not see growth expectations return whence they came (2%- plus per annum), but it will do enough to force markets to rethink current monetary expectations and price further upside into the rate path. Sterling should benefit because it is still so low in trade-weighted terms," says Juckes.
Above: Societe Generale graph. Trade weighted sterling and consensus for UK GDP.
The most significant adverse effect to have stemmed from the referendum to date has been a sharp rise in inflation, brought about by the devaluation of Sterling, which saw the consumer price index rise from 0.5% during the month of the vote to a peak of 3.1% in November 2017. This not only crimped the rate of "real GDP" growth in the UK but also prompted the Bank of England to raise its interest rate for the first time since before the financial crisis.
Bank rate now sits at 0.5% and traders in interest rate derivatives markets are betting heavily that the BoE will raise it by another 25 basis points at its next meeting in May, which would take the main UK interest rate to 0.75%. However, pricing in those same interest rate markets also suggests that the next subsequent rise will not come until well into 2019.
Any chance for the better in this pricing would be sure to have a positive impact on the value of Pound Sterling and it is this that Societe Generale's Juckes says will help to drive the British currency higher during the months ahead. Meanwhile, Swiss interest rates are still sat below the zero level but the currency's safe haven status has prevented it from falling in recent years, which has left the Franc grossly overvalued in the eyes of some strategists.
Above: Societe Generale graph showing exchange rate and interest rate differential.
"The Big Mac index would suggest that the CHF is the most overvalued major currency, though then OECD would argue that it is in competition with the NOK. Either way, GBP is substantially undervalued. That helps the GBP, but we also expect further CHF weakness against EUR as capital finally flows out of low-yielding Swiss markets," Juckes adds.
Juckes and the Societe Generale team have recommended that clients of the bank bet on a further rise in the exchange rate, entering speculative trades around the 1.3605 level and targeting a move up to 1.43 over the coming months. They advocate placing a stop loss at 1.28.
This trade idea comes closely on the heels of a similar recommendation by economists and strategists at Swiss investment bank UBS, who also advocated buying the Pound-to-Franc rate this week. They say the pair is likely to move as high as 1.39 over the next twelve months.
However, both of these trade ideas are about six months behind a recommendation from currency strategists at Bank of America Merrill Lynch, made available to the media in November 2017, who advocated that their clients bet on a move above the 1.40 threshold. They used a complex derivatives (options) strategy that would pay out if the exchange rate rises above 1.40 while limiting losses in the event that the bet does not work out.
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