The British Pound to Remain Strong into Year-End say Credit Suisse, More Optimistic About Trajectory in 2017

• Pound to Euro exchange rate reference: 1.1847
• Euro to Pound Sterling exchange rate reference: 0.8442
• Pound to Dollar exchange rate reference: 1.2569

Credit Suisse believe Pound Sterling's potential for sharp declines in 2016 and 2017 have faded but beware potential volatility in January.

The Pound could remain around recent ranges through to the end of 2016 argue analysts at Switzerland's Credit Suisse.

In a month that saw Donal Trump win the US election and trigger a rally in the US Dollar (index) to 12-year highs, one of the few currencies which actually beat the Dollar, was the Pound.

The strength some by surprise, particularly those market-watchers who reckoned it was a one-way ticket into oblivion for a country that would face terminal decline owing to its decision to exit the European Union.

Of course that view is a misguided one and what we have learnt is that Sterling was left looking oversold as the UK economy will actually remain afloat over coming years.

FX Strategist Bhaveer Shah, at Credit Suisse's London office, argues that the Brexit story - or rather politics in general - is unlikely to worry the Pound over the course of the remainder of 2016. 

"With this week’s UK Supreme Court hearing generating ample noise, one obvious factor that may have helped the pound in recent weeks is the perception that the dial has shifted somewhat away from a hard-Brexit scenario," says Shah.

The Pound weakened to its 1.1450 lows in October due to fears the government was going to trigger a hard-Brexit which would bring the UK out of both the EU and the common market, which is the EU’s trading club.

Shah notes how concerns have softened recently and this has given Sterling a boost.

“Indeed, the tone of the conversation does seem to have softened a notch from the extremes of October, with attention shifting to technicalities that might delay or soften Brexit,” says Shah.

One such technicality is whether the UK might still legitimately claim to have access to the single market via Article 127, even in the event of article 50 being triggered.

Another technicality is whether Parliament can have a say on Brexit, which is being deliberated in the law courts at the moment.

“As long as the door is sufficiently ajar to such possibilities, however slim, we believe GBP may remain supported,” says Shah.

For Credit Suisse the outlook for the Pound rests with what can be explained as a Brexit dial characterised by hard-Brexit on the one side and soft-Brexit on the other.

Where the dial lands is where the Pound should find its new fair value.

Latest Pound / US Dollar Exchange Rates

	Live: 1.3323▼ -0.03% 12 Month Best: 1.3789
*Your Bank's Retail Rate	1.287 - 1.2923
**Independent Specialist	1.3136 - 1.319 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Rising Inflation Could Make Brexit Less Popular

Shah also sees the possibility of a festive squeeze on consumers from higher inflation.

He shows a chart which illustrates that an average basket of Christmas goods has gone up 5.0% in 2016 compared to only 0.1% in 2015.

A delay in the impact of higher inflation on consumer’s pay has meant that the public have not felt the full impact of Brexit on their wallets.

However, when they do their support for a hard-Brexit may wane, putting pressure on the Government to soften its stance which could keep Sterling supported.

Pound Open to Potential Volatility in January

The Pound could be subject to more volatility in January when the Supreme Court announce their decision on whether the Government can trigger Brexit alone or requires an OK from Parliament.

Shah notes how option markets are not fully pricing in the risk of this happening in option prices.

Whilst this may represent an opportunity for option traders it also shows markets remain too ambivalent about Brexit volatility.

Since the decision could go either way this supports Credit Suisse’s thesis that GBP may be overvalued.

That said, we would argue that the outcome of the Supreme Court case has rapidly become irrelevant. 

The Government this week acceded to the opposition Labour party's demands for the Government to publish its plan for Brexit before Article 50 is invoked.

A government amendment went before Parliament setting out the deadline for a March triggering of Article 50 was overwhelmingly backed by law-makers thanks to the Government's concession to publish plans.

So we know Parliament will allow Article 60 to be triggered regardless of the court case.

Latest Pound/Euro Exchange Rates

	Live: 1.145▲ + 0.06% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1061 - 1.1107
**Independent Specialist	1.129 - 1.1336 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Bonfire of Speculative Shorts not Done

The final factor Shah looks at to gauge the Pound’s resilience is the balance of positioning of large currency speculators.

His conclusion is that part of the rally since the October lows has been because of traders unwinding their short positions in what is called a “short squeeze” or “short covering rally”.

This happens when lots of traders have sold short an asset, which means they have speculated it will go down, and it suddenly comes back up.

The short squeeze occurs due to all the speculators who were short hastily closing their trades.

This adds fuel to the rally and propels the asset even higher, thus creating the short covering rally phenomenon.

However, despite finding evidence of this in GBP/USD, Shah says it is not enough to explain the whole rally:

“It is clear that there has been some reduction in stretched GBP shorts – yet the scale of this does not seem extreme either.”

The support provided by this short-covering could therefore run further.

The 'Special Relationship'

One factor to the rally which Shah does not mention is the impact that the election of president Trump had on expectations of the UK negotiating a special trade deal with the US.

Trump said he would place the UK at the front of the queue for a deal – in contrast to Obama saying he would place the UK at the back.

This no doubt also had a strong supportive effect on Sterling.

Forecasts

The new political climate makes Shah more optimistic about GBP/USD’s trajectory.

From seeing it languishing at 1.20 or below, he now forecasts the pair remaining in the 1.20-1.30 range until the end of 2016, with a forecast of 1.20 in 3 and 12 months’ time.