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Pound Sterling Outlook: No-Deal Brexit "Doomsday Interpretation seems Overdrawn" say ANZ

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- Markets less pessimistic about a 'no deal' say ANZ

- Sterling already carrying a chunky premium re. Brexit

- Could end 2019 near 1.40 vs. U.S. Dollar

- But could go below 1.10 vs. Euro according to forecasts

Foreign exchange strategists at global investment bank ANZ say they believe investors are less pessimistic about the prospects of a 'no deal' Brexit transpiring than previously assumed and this explains the recent gains made by the British Pound.

Sterling is looking to cement recent gains and is in fact the best performing major currency of the past week with a 1.0% gain coming against the Euro but a more meagre 0.10% gain coming against a rejuvenated U.S. Dollar.

The Pound-to-Euro exchange rate has recovered above 1.12 having been as low as 1.1127 and the Pound-to-Dollar exchange rate trades at 1.3084 having been as low as 1.3062 earlier in the week.  The market's reaction to the September Federal Reserve meeting could yet see the Dollar pip the Pound for this week's best performer prize.

The Pound's recovery comes as markets continue to hold out for a Brexit deal to be agreed and that much of the negative talk regarding the current state of Brexit talks is posturing as negotiators enter the final straight before the finish line which is the special November E.U. summit scheduled by European Council President Donald Tusk in Salzburg last week.

But, ANZ reckon that there is also the possibility of markets reflecting that a 'no deal' might not be the cataclysm for Sterling that other analysts are expecting, and therefore the downside risks posed by a 'no deal' Brexit are not as great as many in the market believe.

"Without a breakthrough, Sterling is vulnerable in the near-term, but recent price action indicates that investors may be less pessimistic about a 'no deal'," says Brian Martin, Head of Global Economics with ANZ in London.

This flies in the face of consensus in the foreign exchange market place which has the majority of strategists arguing a 'no deal' Brexit poses significant downside to the value of the Pound.

"If it were to happen, our FX strategists argue that a combination of heightened uncertainty and prospective adjustment could precipitate a 10% nominal Sterling depreciation in the first six months," says Adrian Paul, a foreign exchange strategist with Goldman Sachs in London.

The Pound-to-Euro exchange rate is meanwhile forecast by UBS to trade at 0.88 in 2019 in the event of a hard 'no deal' Brexit - that is well below parity. Today, the exchange rate is quoted at 1.12; this 'doomsday' scenario implies a 20% decline in value within the space of a year.

 

It's Already in the Price

Yet ANZ argue that the current levels in Sterling against the likes of the Euro and U.S. Dollar might suggest it has already discounted the majority of the negatives posed by Brexit.

"Sterling is already carrying a 30 cent discount to long run value against U.S. Dollar," says Martin.

"Of the potential Brexit resolutions, the most uncertain scenario is that negotiations are not extended beyond 29 March 2019, withdrawal is agreed and the UK leaves the EU without a transition period. This would cause significant economic disruption. Yet, a no deal has been looking likely for some months, and the economy is doing well. Increasingly, the doomsday interpretation seems overdrawn," says Martin.

Data has been supportive this month with wages, inflation and retail sales figures all coming in above expectation and suggesting the economy continues to grow in a manner consistent with the need for further interest rate rises over coming months. 

"The UK is growing at the same pace as the euro area and wages are rising faster than in the EA. Core fundamentals have improved. Uncertainty may still intensify, but a persistent and sharp fall in GBP requires heightened economic dislocation," says Martin.

"So far, that has failed to materialise and contingency planning by the U.K. and E.U. suggests it might not," adds the economist.

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ANZ's Forecasts for the British Pound

ANZ forecast the Pound to end the year at 1.30 against the U.S. Dollar, suggesting it's a case of sideways action for the pair as negotiators thrash out a Brexit deal.

Expect gyrations around this figure as bouts of uncertainty prompt volatility in Sterling.

However, by December 2019 ANZ forecast the GBP/USD exchange rate to have recovered to 1.40.

The GBP/EUR exchange rate is meanwhile forecast to read at 1.1235 by year-end 2018, have of a decline to 1.09 by year-end 2019.

Readers might be wondering why the Pound is missing out on a recovery against the Euro, particularly when the Pound is expected to recover against the U.S. Dollar over the same period.

The answer lies with an expected broad-based rally in the Euro exchange rate complex, largely thanks to the European Central Bank tightening monetary policy i.e. raising interest rates.

"Over the medium term we remain bullish, this is contingent on the economy continuing to improve and the ECB becoming more hawkish," says Been.

ANZ note Eurozone growth is stabilising, momentum is strong, labour market resource utilisation is rising, wages are rising, industry capacity utilisation is close to its highs, credit growth is expanding, house prices are rising and the ECB is confident that core inflation will move, gradually but persistently, towards target.

"These are not the conditions for a persistent slide in the euro. Barring a negative shock, we continue to expect modest euro appreciation over the forecast horizon," adds Martin.

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