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Pound-Dollar Rate "Undervalued" and Eyeing 1.40 amid Renewed Investor Interest in Sterling

- GBP/USD said to be undervalued and on route to 1.40.
- As GBP fundamentals improve, investors show interest.
- Amid fading fears of BoE, mounting vaccination success.

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  • GBP/USD spot rate at time of writing: 1.3620
  • Bank transfer rate (indicative guide): 1.3238-1.3334
  • FX specialist providers (indicative guide): 1.3411-1.3520
  • More information on FX specialist rates here 

The Pound-to-Dollar exchange rate is undervalued and likely on course for a multi-year high in the coming months, according to strategists at Commonwealth Bank of Australia (CBA), as investors show renewed interest in Sterling in response to a series of favourable fundamental developments.

Pound Sterling was an outperformer last week and sat around the middle of the major currency rankings for 2021 on Tuesday after Bank of England (BoE) Governor Andrew Bailey's appeared to pour cold water over the previously-popular idea that negative interest rates could've been becoming a likelihood. 

"GBP/USD pushed over 1.36. We see the risk it trades closer to 1.4000 over the next few months because GBP/USD is undervalued," says Joseph Capurso, a strategist at CBA, citing a current account deficit that has recently narrowed to its smallest size since 2012.  

Bailey's remarks catalysed a rally that had failed to materialise earlier when the House of Commons nodded through Prime Minister Boris Johnson's agreement covering trade in goods and other aspects of the relationship with the EU.

"While some businesses appear to be struggling to navigate the new EU trading environment, other UK firms appear unperturbed by the new trade landscape (NPR). Some of this likely depends on the specialty of their products and ability to expand their customer base to other parts of the globe," says Clyde Wardle, a strategist at HSBC. "Either way, ONS data show UK trade is likely to take a hit in the first quarter, with fewer lorries crossing the Channel and fewer port visits, though some over-stocking in 2020 may be partly responsible."

 Above: Pound-to-Dollar exchange rate with Fibonacci retracements of 2016 downtrend. 

Investors had perceived the odds of a subzero Bank Rate to be rising when the government returned the country and economy to 'lockdown' in January but, and although this third shutdown could last for months yet, developments at the BoE and in relation to vaccinations have held more sway over Sterling.

More than four million people had received their first dose of a coronavirus vaccine on Tuesday, meaning more than 10% of the population have now either been inoculated or already had the virus, given 3.4 million positive tests. 

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"Net GBP long positions surged to their highest level since March 2020 on speculation that negative rates may not be used by the BoE, at least imminently. Speculators may also be relieved by the skinny trade deal agreed between the EU and the UK and by the rapid vaccine roll out in the UK," says Jane Foley, a senior FX strategist at Rabobank, citing Chicago Futures Trading Commission data covering the week to January 12. 

BoE Governor Bailey's remarks on negative interest rates led British government bond yields to rise even further than U.S. government yields over the last fortnight, providing support to Sterling, although it may be the case that removal of the negative rate threat was simply the catalyst which led investors to buy into a multifaceted Sterling story. 

Source: UK Government Dashboard. 

This is with the UK on course for a headstart in a forthcoming economic recovery from a winter slump that was not as bad in November as many economists had feared, according to Office for National Statistics data that revealed a -2.6% decline in GDP for that month last Friday.

"Our forecasts assume that the severe COVID-19 restrictions remain in place in January, February and March, that they are eased only gradually in April, May and June, but that a rapid rollout of COVID-19 vaccines means few restrictions are required beyond June," says Paul Dales, chief UK economist at Capital Economics. "Our view that the economy will return to its pre-pandemic size in Q1 2022 and that it won’t be permanently smaller due to the pandemic is a more optimistic take than that of most forecasters. It implies that the government doesn’t need to tighten fiscal policy to reduce the budget deficit from 20% of GDP in 2020/21 back to pre-pandemic levels of around 2% of GDP."

Britain's recovery prospects are burnished by the second largest vaccine order book in the world after Canada and early success in making vaccinations available to the population. If the government achieves its aim of vaccinating 15 million by the middle of February, then more than a quarter of the population would have been inoculated or already had the virus by that time. However, The Telegraph reported at the weekend that all adults are likely to have had an opportunity to be vaccinated by the end of June.

Above: Pound-to-Dollar exchange rate with Fibonacci retracements of 2016 downtrend. 

"We're not surprised to see GBP and AUD showing significant improvements in their positioning profile," says Francesco Pesole, a strategist at ING. "Both currencies rallied significantly towards the end of 2020, as idiosyncratic factors (the Brexit deal for GBP and iron ore rally for AUD) contributed amid a generalised weak-USD environment. Still, GBP net-longs are at 8% of open interest, AUD net-longs at 4% of open interest, which compared to the rest of the G10 space (excluding the outlier CAD) are rather small figures."

The government's vaccination strategy means the UK could be among the first to achieve herd immunity and as soon as this summer, which could enable sustainable steps out of 'lockdown' sooner than elsewhere and could help to support the Pound. Sterling could be further supported by the fact that investors' bets in favour of it remain underweight compared to other major currencies as well as historical norms for the speculative trading in British exchange rates. 

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The Pound may be further supported by the likelihood that it proves key to sustaining a rally in the Euro as it's one of a few components of the Eurozone's trade-weighted exchange rate that actually has scope to rally further and which is also large enough to ease upward pressure on the trade-weighted Euro. 

"GBPUSD may see further near-term consolidation beneath the “neckline” to its 2018 top at 1.3710/20 but with a major base in place above 1.3514, our core outlook stays bullish for an eventual break with resistance then seen at 1.4000 nextahead of our first core upside objective (from last September) at 1.4302/1.4377 – the 2018 high and 50% retracement of the fall from 2014," says David Sneddon, head of technical analysis at Credit Suisse. "Whilst we would expect a fresh consolidation phase here, the big picture is that we look for an eventual break and a move to our 1.4986/1.5136 raised objective."

Souce: Credit Suisse.  

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