Brenda Kelly, lead analyst at London Capital Group, writes exclusively for What Investment on the outlook for sterling for the rest of 2016.
The continuing threat from global terrorism combined with general sentiment towards the EU may well see the polls move towards the Brexit end of the scale as we approach the date of the referendum itself.
At present, there is around a 40-45 per cent chance of a vote to leave. But a lot can happen in a week and a lot more can happen over the course of 11 weeks too.
An exit could well cut growth potential in the UK by 0.5-1 per cent per annum, particularly since the EU is the largest market for the UK in respect of exports. The notion of having to renegotiate trade agreements is not something that will happen overnight but may well take years to deal with – during that time we can likely expect to see a serious blow to sterling strength.
The Boris effect was short-lived – the pound tumbled below $1.40 to a 7 year low but the effect on the EURGBP has been far less dramatic and volatile – just a slow steady move lower against the single currency as a result of risk aversion in the broader markets.
The move back to $1.4450 was a flash in the pan and we now witness the pair trading below the $1.43 level. Now we can call this Brexit risk but it’s in the main down to the pretty dastardly large trade deficit that the UK now holds. Britain’s trading position with the rest of the world has deteriorated sharply with the current account deficit swelling to its widest on record, fanning fears about the sustainability of the economic recovery. It swelled to £32.7 billion in the fourth quarter, equivalent to 7 per cent of GDP, up from 4.3 per cent in the third quarter. This was the highest since quarterly records began in 1955.
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While the ‘remain ‘camp may try to use this as a reason to stay in the EU, there’s no guarantee it will have relevance attached to it with the electorate.
What is more certain is that it will be a major issue if financial markets lose confidence in the UK economy. The trigger here could well be the outcome on June 23.
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When it comes to forex, there will always be several drivers and the moves will not always be sterling related. We remain uncertain as to the next move from US interest rate setters,, but markets are not pencilling in any real possibility for another rate hike until November of this year. The very idea of a rate hike from the Bank of England is barely countenanced for now – it’s more likely to occur in the middle part of 2017.
The effects of the low oil prices have made their mark on inflation here and we remain steadfastly below the 2 per cent mandated level Even the recent rally in Q1 for oil has failed to bring about the expected base effects and the trend for this sector is very much to the downside, politically, technically and cyclically.
Any moves back through 1.40 would add to the bearishness in GBPUSD and any test of the ‘Boris effect’ level will likely see further deterioration. I would expect we trade in the 1.32-1.35 zone as we get nearer to June.
We can expect $1.25 if the UK does vote to leave. But the upside possibilities are still there. We can likely see a surge in sterling to $1.55 if the status quo is maintained.
For EURGBP, sure, we’re through 80p – but the contagion effect may well start to manifest itself in the euro. So I do not expect too much additional upside here – negative deposit rates, additional QE and general jawboning should keep a cap on euro strength eventually. But more importantly, if the UK does vote with its feet, then the speculation will ramp up – who will be next?