Sterling: Another leg down coming – RBC CM

Adam Cole, Research Analyst at RBC Capital Markets, explains that after two post-referendum legs of independent weakness, GBP has become little more than a range trade for the last three months or more, caught between increasingly independent moves in USD and EUR.

Key Quotes

“Although still in a minority, a growing number of forecasters have begun calling GBP higher against EUR and USD in 2017. Whilst recognising some of the risks to our long-standing targets (1.15 for GBP/USD; 0.89 for EUR/GBP) we still think the outlook favours another leg lower.”

“A multitude of factors have acted as a prop under GBP in recent months, but going forward, most look more fragile. Firstly, persistent positive data “news”, upward growth revisions and diminishing expectations of further BoE easing. Going forward, however, rising growth expectations will eventually sow the seeds of their own demise and expectations will overshoot to the upside. Secondly, expectations that the easing of policy through previous GBP weakness will support activity. Recent trade data, however, are consistent with the failure of export volumes to respond to GBP weakness, which will become an important theme in the UK as it has in Canada. Prices have risen strongly, volumes are little better than flat.”

“Finally we would note an underappreciated prop for GBP in recent months has been the outperformance of financial equities globally, to which GBP has been historically very sensitive. Again this may have limited GBP downside, particularly in the post-US election period, when the outperformance of financials has accelerated. This may or may not continue going forward, but we would not count on it continuing to hold GBP up in the way it has recently. So, taking all of this together, we think there have been a number of factors working in GBP’s favour that can’t be counted on to hold it up going forward. We maintain a target of 1.15 for the low in GBP/USD, though we have pushed forward the timing to Q2 from Q1.”