Adam Cole, Research Analyst at RBC Capital Markets, suggests that GBP’s “flash crash” on October 7 briefly took GBP to RBC’s medium-term target of 1.15 before most of the losses reversed.
“In reality, the move had little to do with news flow and tells us little about the underlying supply/demand balance for GBP and the bottom line is that we are not changing our short or medium-term expectations for GBP, which imply some stability returning in the remainder of the current quarter, before another significant leg lower.
Prior to the chaotic moves on October 7, GBP was already under pressure after PM May set a deadline of end-March for triggering Article 50 (a significant minority appear to have thought it would never be triggered), though a large part of the fall in GBP/USD in September/early-October is USD strength rather than GBP weakness. With US markets now pricing a high probability of a Fed hike before year-end and UK economic data holding up well (our UK economic surprise index is at +25), we expect GBP/USD to consolidate around current levels in the remainder of the year.
6-12 Month Outlook – GBP/USD to 1.15
Many of the activity indicators currently being released, although relating to activity post-referendum, will have been heavily influenced by decisions made pre-referendum and on the assumption of a vote to remain. Only when we start to get a clear picture of the economy in Q4 (around the turn of the year) will we really have much idea what the short-term impact of the vote has been and the real household income squeeze resulting from GBP’s fall alone should ensure that the impact is negative.
We also see scope for disappointment on the positive impact of GBP’s fall on economic activity, which is likely to be limited to higher exporter margins, with little follow through in volumes and hence employment and investment. UK/EU politics is also likely to remain quiet until Article 50 is triggered (end-March 2017 at the latest). Early indications are that the negotiations will be difficult and will extend well beyond the two year deadline (which only covers leaving arrangements). Timing is imprecise, but late-Q4 or early-Q1 should see coincident pickup in negative economic and political news.
The UK’s current account position and its domestic counterpart (the budget deficit) remain a medium-term funding concern for GBP and the impact of GBP weakness so far will be limited and still leave the external imbalance unsustainable in the medium-term. Our 1.15 target for GBP/USD is unchanged.”
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