The British pound could fall all the way down to 1.22 against the US dollar in 2016 argue Sweden's Handelsbanken. Here are the reasons why.
While we had the forecast figures we did not have an explanation to the numbers.
The 1.22 forecast for GBPUSD, as explained here, is well below the consensus forecasts for end-2016 that we have in our surveys.
I have since caught up with Handelsbanken Capital Market’s Senior Economist, Helena Trygg (pictured above) to dig deeper into the bank’s thinkings. In short, should this prediction be right then we are in for an incredibly 2016.
Of notable interest is that much of the decline in GBP/USD will come largely on the back of US dollar strength, as opposed to some sinister failing in confidence towards the British pound.
“Our GBP forecast vs the USD is more or less driven by the strengthening of the USD as the Fed continues to tighten monetary policy while the ECB will have to do more,” says Trygg.
The pro-USD scenario is evident elsewhere - particularly in the euro / dollar exchange rate which is predicted to break below parity:
“Our main scenario for the EUR/USD is that the USD will strengthen and reach below parity at the end of 2016 to 0.90. With that in mind, and that we see GBP/EUR to move more or less sideways during this year, this will cause the GBP/USD to reach 1.22 towards the end of this year, if we are right.”
When put to her that a number of forecasters are citing the 2016 EU referendum as a major concern for sterling Trygg answered that these risks are most probably already baked into the exchange rate.
“Of course there is a concern when it comes to Brexit and the FX volatility, but this is probably already priced in and investors are still confident as the UK has its own currency, its own central bank and the economy is performing well compared to most G7 countries,” says Trygg.
Nevertheless, the issue of Brexit is a big one and these views muddy the water for us. We had assumed that the referendum would be an all-out negative for sterling.
The notion that Brexit is already in the price of sterling could well be correct; polls are now pointing to a clear majority of British citizens wanting to leave Europe. If markets have enough time to digest the now very real prospect of exiting Europe, then the softer the likely negative impact of an actual exit becomes.
Brexit or not, according to Handelesbanken’s predictions, 2016 will not be kind for those holding out for a stronger pound to dollar exchange rate.
Government to Keep Spending Tight
Credit Suisse told us towards the end of 2015 that this new year would be a tough one for sterling bulls thanks to the dual headwinds posed by the EU referendum AND further cuts to government spending.
Government spending is a potentially significant input into GDP and squeezing back on spending can, it is widely argued, cap economic growth and hold back the currency.
The current government is in a long-term battle to cut UK spending as high levels of spending have seen the UK's debt burden spiral higher over the past two decades.
On Thursday the 7th the UK Chancellor George Osborne warned that global risks are growing and this reinforces the importance of reducing the government’s budget deficit, the Institute of Directors has said.
“85% of IoD members support the Chancellor’s plans to run a small budget surplus by the end of this parliament. They know that without bringing public spending under control, the UK’s debt pile will continue to grow. That means when – not if – the next crisis strikes, it is unclear how well we will be able to weather the storm," says James Sproule at the IoD.
It looks like Osborne agrees with the IoD - and we read this as another hurdle to any significant advances in sterling.
US Economy in Rude Health
The US economy's performance will provide the underpinning to the broader US dollar advance.
On Friday the 8th it was announced that the economy added a further 292K jobs to the payroll in December - way ahead of the 200K jobs that were expected.
The news saw the pound fall back towards multi-year lows against the dollar while the euro was seen below 1.09 again.
"The US labor market continues to be a pillar of strength – not only for the US, but the entire global economy," says Harm Bandholz at UniCredit in New York.
The news out of the US comes at a time when global economic fears have been high on the agenda with developments in China taking centre stage.
"The US labor market continues to be red-hot despite daily reports of global economic headwinds and financial market turmoil. The reason for this resilience – as highlighted at several occasions – is that most of the value added and of the job creation in the US occurs in the services sector, which is barely affected by global developments," says Bandholz.
The dollar is presently being bid higher with markets forecasting four interest rate rises in 2016.
However, Bandholz holds a more USD-negative view that we find interesting.
"The fly in the ointment – if there is one – is still moderate wage pressure. Average hourly earnings were only flat between November and December," says the UniCredit analyst.
As such the bank see three rate hikes in 2016.