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#Investments — 04.07.2017

Outlook Change For The Sterling

Guy Ertz

Why we see less upside for the British Pound.

  • The lack of majority following the June election has increased the uncertainty around the Brexit and the economic outlook, the Sterling suffered against both the dollar and the euro.
  • We believe rising political uncertainty and risks to economic growth will prevent the Bank from raising rates in a foreseeable future.
  • The argument supporting a rising interest rate difference between the UK and the Eurozone has thus become weaker. The outlook relative to US rates is also giving less support the Sterling relative to the dollar.
  • While we still see the risks for the British Pound to depreciate a lot to be low, we need to acknowledge the deterioration of the outlook for the currency. Against the euro we have revised our 3-month target to 0.88 (value of 1 EUR) from 0.83 and our 12-month target to 0.85 from 0.80. Against the dollar the new 3-month target is 1.25 (1.28 before) and the new 12-month forecast is 1.24 (1.31 before).
  • The main risk factors to this scenario are an increase in political uncertainty linked to Brexit and/or a further deterioration in economic conditions.

 

Rising Uncertainty Following The Recent Election

The central bank has been facing the dilemma of rising inflation and a deterioration of medium-term economic outlook. Inflation has been rising due to the weakness of the currency after the Brexit referendum last year. Inflation has been outpacing wage growth thus leading to purchasing power losses. Another reason to increase rates is the rise in the household debt-to-income ratio. The rising uncertainty since the election June 8 this year is however weighing on the consumer and business sentiment and suggests that the rise in inflation could be temporary. The Bank of England has been giving conflicting messages over recent days. The central Bank Governor has been suggesting that the increased uncertainty regarding Brexit negotiations and the economic outlook following the June election, justifies to be more prudent regarding a rate hike The Chief economist however argues in favour of such a measure. The BoE Committee could also turn slightly more cautious soon on the question of rising rates as its most hawkish member will leave the board as her three-year term ends.

Our economic outlook is more cautious compared to the Bank of England. We believe rising political uncertainty and risks to economic growth will prevent the Bank from raising rates in a foreseeable future. The decision of the Financial Policy Committee (FPC) to raise the capital requirements for banks could be seen as a temporary alternative to raising rates.

The argument supporting a rising interest rate difference between the UK and the Eurozone has thus become weaker in recent weeks and this is a key reason to see less upside for the Sterling against the euro. The outlook relative to US rates is also giving less support the Sterling relative to the dollar.


Technical Analysis, Overbought Indicators And Concluding Remarks

The euro is not yet in overbought territory against the Sterling based on the Relative Strength Index (RSI). Indeed, the RSI is well below 70 which is seen as a short-term indicator of overbought conditions.

In terms of technical analysis, the 50-day and 200-day moving average will be the first key support level, both are at approximately 0.86 (value of 1 euro). The formation of a so-called “Golden Cross” (when the 50-day moving average crosses and breaks above the 200-day moving average) can be seen as euro-positive (see chart). There is no systematic pattern however.

While we still see the risks for the British Pound to depreciate a lot to be low, we need to acknowledge the deterioration of the outlook for the British currency. Against the euro, we have revised our 3-month target to 0.88 (value of 1 EUR) from 0.83 and our 12-month target to 0.85 from 0.80. Against the dollar the new 3-month target is 1.25 (1.28 before) and the new 12-month forecast is 1.24 (1.31 before).

The main risk factors to this scenario are an increase in political uncertainty linked to Brexit and a further deterioration in economic conditions.