GBP: To buy or not to buy? - Rabobank

The morning headlines in the UK press are dominated by yet another tale of misfortune for PM Theresa May as her closest ally Damian Green was ordered to resign last night on the findings of a Cabinet Office investigation, points out Jane Foley, Senior FX Strategist at Rabobank. 

Key Quotes

“He is the third Cabinet Minister forced from office in just two months meaning May’s weak position has just become even more fragile.  Predictably sterling weakened on the news yesterday evening and has maintained a softer position this morning.  Since the referendum on EU membership in June 2016, the pound has been buffeted by an almost constant stream of political uncertainty and May’s tenuous grip on power suggests more is likely to follow.  Given this backdrop it is perhaps surprising that GBP is the fourth best performing G10 currency in the year to date after the EUR, DKK and SEK.” 

“GBP’s decent placing in the currency performance rankings in the year to date must be put in context. The pound has still managed to drop 4.1% vs. the EUR this year and this brings the cumulative loss since the June 2016 referendum to around 13.5%.  In contrast to the EUR’s stand out strength this year, the USD is still the worst performing G10 currency in the year to date and this explains the relative buoyancy of GBP/USD.”

“The USD’s fall from favour through the first nine months of this year will also have had an influence on the CFTC speculators’ positioning data.  Through much of this year, the USD was liked even less than GBP by many speculators.  GBP shorts were thus reduced dramatically through the spring.  The appearance of a more hawkish BoE then allowed the pound to take the mantle of the best performing G10 currency in the month of September.  According to the CFTC data the market is now long of GBP.  This arguably will increase the vulnerability of the pound to bad news during 2018.” 

“The deal that PM May negotiated with the EU earlier this month was a success insofar as it opens the way for negotiations of the UK/EU post Brexit trade deal to start. That said, it still has holes which could come back to haunt the UK government.  May has provided a reassurance to the Irish government that there will be no hard border across the island of Ireland and that simultaneously to the DUP (upon whom May’s minority government relies for support in parliament) that there will be not separate treatment for Northern Ireland with respect to the rest of the UK.  It is difficult to see how both of these promises will be kept unless the post Brexit UK/EU trade position is very similar to what is currently in place.  For now, however, the market has parked this issue.”

“The biggest driver of GBP over the coming months is likely to be whether the tone of the forthcoming trade talks are constructive.  If expectations regarding a free trade deal between the EU and the UK start to grow, GBP is likely to find support.  Although we are optimistic about such an outcome, we also see risk that it could be a last minute deal.  In the meantime we see the possibility that GBP could come under fresh pressure vs. the EUR.” 

“A significant influence for EUR/GBP during the course of the year will be central bank activity. During the first nine months of 2018, the ECB will carry on with a tapered QE programme.  Encouraged by the Eurozone’s strong growth performance this year, the market is speculating as to how this policy will develop beyond that and when the first rate hike by the central bank will be announced.  Although the latter is not likely until 2019, it is feasible that such a move will be priced in to the market by the end of this year and that the EUR will continue to draw support from a buoyant economic performance in the region in the coming months.”

“In the UK, the money market is already fully priced for a second BoE rate hike before the end of this year.  Firmer inflationary data, specifically stronger wage data would raises the risk of an earlier move.  However, the UK consumer is currently battling headwinds caused by falling real wages and there are signs that hiring may have peaked.  Against this backdrop we see risk of EUR/GBP drifting towards 0.91 on a 6 mth view and potentially towards 0.95 during the course of the year.  That said we have pencilled in a drop to 0.80 on an 18 mth view.  This assumes that the bones of a free trade pact are agreed for the post Brexit period.”