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BofAML: British Pound's Gains to be Short-Lived

Exchange rates post BoE

Image © kasto, Adobe Stock

The British Pound is unlikely to see the gains granted by the Bank of England's policy decision on Thursday, June 21 last say analysts at Bank of America Merrill Lynch.

The Pound rose broadly in response to news that the Bank is edging towards an interest rate rise - to be delivered either in August or November - and BofAML FX Strategist Kamal Sharma says there is scope for the Pound to advance over coming weeks, particularly if data shows improvement.

After all, the Bank of England has consistently shown itself to be sensitive to the UK economic data pulse, famously pulling out of a well signposted May interest rate rise following a poor start to 2018 for the UK economy.

"Despite the lacklustre evidence that the UK economy has pulled out from its Q1 soft patch, the BoE appears to be in a hurry to hike rates," says Sharma. "In doing so, it becomes one of the first central banks to challenge the policy decoupling narrative that has weighed on non-USD G10 FX."

Sharma here refers to the troubles encountered by most global market currencies against a resurgent US Dollar which is rising thanks to the US Federal Reserve's ongoing policy of raising interest rates.

Global capital tends to flow to where returns are highest and the promise of higher interest rates in the United States has attracted investor attention and the ensuing flows of money have in turn bid up the price of the Dollar.

The reckoning is that higher interest rates in the United Kingdom could provide the same kind of support for Sterling.

Indeed, "whilst it is too early to call this a turning point in GBP, any further improvement in data in coming weeks could provide further impetus to the Pound," says Sharma.

Like a host of other foreign exchange strategists we have heard from over recent days, Sharma believes Sterling's best prospects lie against the Euro which is one currency that can't count on its central bank to raise interest rates.

We heard at the June European Central Bank event that interest rates are unlikely to rise in summer 2019; a time many foreign exchange market participants had been expecting the first interest rate rise in years to take place.

This disappointment was reflected in the Euro's decline against the Dollar, but against Sterling there was little impact.

This resilience in the single-currency might be less forthcoming now that the Bank of England has revealed itself to be in the rate raising camp.

"We would focus on EUR/GBP as the most obvious cross to express some policy divergence," says Sharma.

However, Bank of America Merrill Lynch are slightly surprised at the MPC's focus on tightening ahead of the June 28 EU Summit where many of the Brexit divorce parameters are yet to be decided.

Indeed, we would imagine that any upside in Sterling will ultimately remain limited as long as markets continue to price a 'Brexit premium' into the Pound - i.e. the currency must be artificially cheap to account for any potential negative consequences to the economy stemming from the UK's exit from Europe.

Until this premium is eroded, the Pound is unlikely to fully reflect a fair valuation.

"Notwithstanding our constructive medium-term view on the Brexit end state, we think there much to do before we get to that point. As such, GBP gains may prove limited in the coming week as we approach the EU Summit," says Sharma.

At the time of writing the Pound-to-Euro exchange rate is quoted at 1.1410 and the Pound-to-Dollar exchange rate is quoted at 1.3268.

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