GBP: Don’t buy the dip – RBC CM

Adam Cole, Research Analyst at RBC Capital Markets, suggests that with such a large, and likely extended, degree of uncertainty hanging over the UK’s relationship with the EU, and similar uncertainty on the near-term impact on activity, it is unlikely that GBP will move quickly to a new, stable equilibrium.

Key Quotes

“Despite the magnitude of GBP’s initial drop on Friday, we would note that the 7% fall (average against USD and EUR) is, so far, very small in the context of historical collapses.

The two main uncertainties overhanging GBP are the negotiations on exit itself, formally commencing once an Article 50 request for withdrawal takes place, and the impact that elevated uncertainty has on activity in the coming months. On the former, there is a body of opinion that the process will be both straightforward and amicable. We don’t expect that to be the case and the initial, somewhat acrimonious, response of European Commission President Junker to UK PM Cameron’s proposed delay to October does not point to an easy divorce.

UK activity was already slowing in the run-up to the referendum, though our economists think only part of that is explained by referendum uncertainty itself. In line with their assessment of the economics of UK exit ahead of the event, they retain the view that the initial period of uncertainty about the process for EU withdrawal will exert a cost on economic activity and that the resulting loss of output and increase in spare capacity will result in a bias for looser monetary policy.

It will be months or even quarters before we have sufficient data to make an assessment of how hard UK activity has been hit by rising uncertainty and for now, we stick with our pre-referendum call that markets are likely to assume a “typical” UK recession, with the shock to confidence causing output to fall somewhere between 2% and 4%. It seems highly unlikely that this, or the policy response to it, has been fully priced into GBP yet.”