Pound to "Continue to Weaken" against Dollar says Goldman Sachs

Above: A view of the Goldman Sachs stall on the floor of the New York Stock Exchange. REUTERS/Brendan McDermid/File Photo.

Goldman Sachs says a recent rebound in Pound Sterling is partly a result of the disruptions in UK pension plans which has led to some significant, but temporary, repatriation back to the UK in order to raise capital.

As such Sterling's recent strength is likely to be short-lived as it suffers "flawed fundamentals" according to the Wall Street investment bank.

"Ultimately we expect Sterling to continue to weaken," says Michael Cahill, G20 foreign exchange strategist at Goldman Sachs.

The Pound to Dollar exchange rate fell to an all-time low at 1.0345 in the wake of the government's 'mini budget' that saw a raft of unfunded tax cuts announced that lead investors to worry the UK's fiscal outlook was becoming unsustainable.

But Sterling staged a rally back to 1.15 following the Bank of England's intervention in the Gilt market where it bought up long-dated gilts to suppress their yields.

Goldman Sachs says there were likely two main elements behind the recovery by the Pound.

The first is that the Bank of England's intervention in gilt markets might have contributed to a global narrative that "peak hawkishness" had been reached.

Markets have struggled, the Dollar rallied and the Pound fell as investors prepare for ever-higher interest rates, particularly at the Federal Reserve.

Therefore, the 'peak' in this narrative would also represent the peak pain point for assets such as the Pound.

"This led to a partial reversal of the 'Sterling downdraft' that had accelerated the Dollar trend in September (and finally pushed the Euro away from parity)," says Cahill.

A second reason involves UK pensions.

"We think that the disruptions in UK pension plans have led to some significant but temporary repatriation back to the UK in order to raise capital. However, this should be a temporary phenomenon, and ultimately we expect Sterling to continue to weaken in coming months," says Cahill.

Goldman Sachs says the market is demanding a higher risk premium on UK assets, and recent Bank of England and government actions suggest that policymakers will be more willing to allow this re-pricing to occur via the currency rather than significantly higher yields.

Goldman Sachs economists meanwhile expect the Bank to raise rates by "only" 100 basis points at the next meeting, which is only slightly more than was expected before the fiscal event.

By not going harder the Bank is showing concern for UK mortgage rates which have shot higher of late.

A key near-term risk for the Pound is a host of speeches from members of the Bank of England's MPC.

Speakers due this week are Sir John Cunliffe (Tuesday), Governor Andrew Bailey (also Tuesday), Jonathan Haskel (Wednesday), Chief Economist Huw Pill (Wednesday) and Catherine Mann (Wednesday and Thursday).

"This week will present a further test for Sterling, as the Bank's temporary purchase program expires and policymakers seem likely to signal that at least for now they still expect to begin winding down the balance sheet at the end of the month," says Cahill.

The Bank released a statement on Monday saying it would increase the daily limit of its bond buying package ahead of the programme's expiry on Friday.

Price action in bond and foreign exchange markets over the coming days will therefore give a clear sign as to whether or not the Bank has done enough to steady sentiment.

"Overall, we think the temporary Sterling strength was mostly due to some aggressive, short-term Sterling demand, while over the next few months macro fundamentals and a difficult policy mix are likely to lead the Pound back to the lows," says Cahill.

Goldman Sachs maintains a three-month target on the Pound to Dollar exchange rate of 1.05. (If you are looking to secure your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.)