Sterling to remain soft for now – ANZ

The UK-EU free trade agreement (FTA) is welcome, in that it avoided a hard Brexit for merchandise trade. However, trade friction has risen and the government has yet to clarify its post-EU industrial strategy, which needs to be focused on productivity. Beyond a relief rally, the FTA does not provide a compelling reason to buy GBP now. Thus, economists at ANZ Bank anticipate some underperformance.

Key quotes

“Against the dollar, sterling is still 10% below its pre-2016 referendum level. Using OECD producer prices, it is estimated to be 8.5% undervalued vs USD. We think, given the immediate challenges facing the economy, a discount to fair value is justified.” 

“From a policy perspective, an undervalued exchange rate is helpful in the short-term as it is helping to maintain accommodative financial conditions as the economy battles the COVID-19 crisis. Low inflation and the large output gap created by the pandemic mean that the possibility of negative interest rates in the future is real. Financing a large budget deficit under negative policy rates could require a depreciation in sterling to compensate foreign investors for taking UK risk.”

“Until greater economic certainty emerges, which it will do in time, sterling may underperform. We forecast that it will rise against the USD as part of a broad-based dollar sell-off, but anticipate that it can underperform on the crosses. The relatively favourable cyclical position of the Australasian economies, their better fiscal outlook, deepening APAC regional trade arrangements and diminished requirements for additional monetary easing across the region argues in favour of regional FX outperformance versus GBP.”