GBP lacking rate or yield support – SocGen

Kit Juckes, Research Analyst at Westpac, suggests that sterling, since the Brexit vote, has been lacking rate or yield support. GBP is currently threatened by politics, but supported for now by economic resilience, he further adds.

Key Quotes

“If you’d gone out on the eve of the UK ‘Brexit’ referendum, sold GBP and bought the ISK, leaving the cash on deposit, you would have made a return of 43% over the last year. 41% if you’d bought ZAR, 39% in RUB. You could have lost money on the spot side of the trade only by buying the TRY, but the losses would have been outweighed by interest. Every currency we track has been a better place to invest than sterling. That’s been helpful for UK equities, which are up 18.5%, but that’s nothing compared to the 50% return the Nasdaq has delivered in sterling terms.”

“When I look at the scale of these returns from shorting sterling, they deliver a warning – that the pound is cheap. Similar returns from shorting it now are almost inconceivable. However, a glance at real yields in the UK, Germany, Japan and the UK highlights how little interest rate support there is for sterling. 3-month nominal rates don’t tell quite such a dramatic story in absolute terms, but they certainly do in relative terms.”

“So the pound is helped by the size of its fall. It’s helped by valuations too. A shrinking current account deficit has reduced the scale of one anchor holding it down (we’ll know more on this next week, when Q1 data are released) but at 2.45% GDP in Q4, it’s hardly a positive for the currency. But the biggest support for sterling, so far, has been the resilience of the economy to a sentiment shock from the vote to leave the EU. Real GDP grew by only 0.2% in Q1, but that’s still 2% y/y, matching the US growth rate and beating Japan and the euro area. Employment has increased by 1.2%, which keeps productivity growth down, but despite falling real wages, retail sales volumes have grown by 2.6% y/y over the last three months.”

“The Prime Minister is trying to form a viable government. The Europeans say they would love the UK to withdraw the move to trigger Article 50. The acid test for sterling however, will come from the economy and from the real wage squeeze. That is likely to play out slowly, not quickly.”