Sterling pounded: what do the experts say?

Following the huge sterling 'flash crash' last week, the pound has continued to subside and on Tuesday morning dipped below 1.23 against the dollar for the first time since the mid 1980s.

Last week's second-largest daily decline in the pound's history and the ongoing weakness are widely attributed to growing worries about a hard Brexit.

But below are the comments from a selection of analysts and strategists on the pound, citing other factors weighing on the currency and the near-term outlook.

Sterling summary

Providing a summary of the background situation, David Morrison at Spreadco said some of this week’s negativity can be dumped at the dollar’s door as the likelihood of a Fed rate hike before the year-end has increased, but it's mostly down to Brexit concerns.

"The trigger for the latest reset was the Tory Party conference and the fear that the government is prepared to ditch access to the single market in order to take back control of immigration. The concern is that will lead to an exodus of banks and other financial institutions from the UK and that in turn will lead to falling tax receipts and a further widening of the budget deficit…not helped by the Bank of England cutting the headline back rate and restarting quantitative easing in August and making clear they are ready to loosen monetary policy further before the year-end."

Export benefits may soon be offset

Strategist Kit Juckes at Societe Generale said the pound was falling in spite of "no new news or data" on Tuesday, but he emphasised that the benefits seen to be enjoyed by companies with strong levels of exports would soon be counterbalanced by other factors.

"Press comment is now shifting to embracing the positive effects of a weak pound and in due course that’ll be true, but any further weakness from here might simply reflect loss of confidence and be bad for UK assets (gilts, equities, house prices, you name it...) in general."

Quandary for Carney

Noting that the 16% decline of sterling in 2016 has seen it likened to that of an emerging market (EM) currency, Rabobank's Jane Foley saw further downside potential for sterling from the heightened risk of more volatility in the pound and the UK’s sizeable current account deficit from the government's political manoeuveres.

"In an EM country, analysts would be weighing up the chances that the central bank would have to start thinking
about an interest rate hike to stabilise the currency. In the UK however, many economists are still looking for the BoE to
cut rates again next month."

Foley also pointed out that the plunge in the value of GBP was lifting inflation expectations in the UK are on the rise and has seen a jump in 10-year gilt yields, which she sees leading to the BoE governor Mark Carney overseeing no change on interest rates for the rest of the year.

"In contrast to the relationship that has sustained for some time, higher yields have been unable to bolster the position of the pound with political uncertainty overriding the attraction of stronger returns. The risk for the Bank is that another cut in interest rates this year could accentuate the downside potential for GBP," she said.

"Not only could further FX volatility alienate investors but it could lead to a rise in inflation expectations. This could exacerbate the sour tone in the gilt market and bolster long term interest rates further."

Accendo

Dovish chat from the Monetary Policy Committee’s newest member, Michael Saunders, was highlighted by Mike van Dulken at Accendo Markets, with the ex-Citigroup economics chief saying he "wouldn’t be surprised if sterling fell further".

Van Dulken also drew attention across the Atlantic: "Making matters worse is a rampaging USD Index, close to regaining late July highs on receding fears about a Trump triumph as Republicans shun their nominee and market implied odds of a December Fed rate hike having risen to 75%. Last week’s lows of 1.18 in the midst of a thin volume fuelled flash crash nonetheless mean we have a new marker in the sand."

"This offers potential for any serious Brexit jitters (or indeed continued USD strength) to send Cable back there again."

The Accendo man noteed that the round number of $1.20, which is 10% down from post Brexit highs and 19% since the Brexit decision, has been pegged by many FX analysts as a low point, "so it would likely find some support here first before any test for fresh 31yr lows".

Beware further flash crashes

Bank of American Merrill Lynch said the speed and magnitude of the flash crash emphasised the more "furtive dangers" of worsening liquidity, which is most acute in the Asian Pacific session.

"This, in turn, results in greater risks of flash crashes, like the one we saw last week. Indeed, over the course of less than 10 minutes, the over-6% decline in sterling (against the dollar) coincided with less volume transacted than the total volume from 1.28 to 1.26. Furthermore, this move was the single-largest reading in the actual volatility relative to expected volatility based on volume."

Plenty of room for more losses

Another warning came from RBC Capital Markets as it drew attention to Friday’s data from the International Monetary Market that showed net GBP shorts at a new all-time high, not including the flash crash on Friday.

"Some have used IMM positioning as an argument that GBP positioning is too crowded for further losses but last week is a good reminder that that is not the case.

"Note also that net shorts are not the best way to gauge position as in absolute sizes both longs and shorts are up. If you scale net GBP shorts by open interest, you find short GBP positioning is not even as heavy as it was a month ago."

The Canadian bank also noted that net CAD shorts increased to -14k, the highest they have been since March in absolute terms and scaled by open interest.

Baer-ish stances are standard

Looking at the euro's relationship to the pound, Julius Baer acknowledged that markets see increased risks of a "hard Brexit" and therefore adjusted its three-month forecast down-ward to EUR/GBP at 0.89, in order to maintain a neutral outlook.

For long-term outlook it remains bearish, revising its forecast rate slightly to EUR/GBP at 0.94 "to reflect the turn of the month, assuming that, in a year from now, Brexit-related outflows of foreign direct investments will be the single major driver to weaken the pound further".

Euro parity looms larger

UniCredit's chief economist Erik Nielsen sees parity to the euro for the pound before long: "After all, this is a country running a current account deficit of about 5.7% of GDP – which translates into a need to attract foreign capital to the tune of about £10bn a month just to finance the over-consumption and to keep the FX stable."

The bank's head of FX strategy, Vasileios Gkionakis, in the wake of last week's crash, said the severe pressure on sterling showed investors are becoming concerned "not only about the UK’s free access to the single market, but, more generally, about the country’s vision on immigration, openness and business friendliness - this could be detrimental to the outlook for sterling."

He added: "It remains to be seen whether the decline in sterling and investor concerns will lead to some political U-turns aiming to calm markets and restore some of the lost confidence. If so, this could grant a short-term respite to the currency, especially as shorts have been extended and the GBP went into a tailspin."

UniCredit forecasts GBPUSD at 1.20 and EURGBP at 0.93 by year-end, "although risks are now for further GBP weakness".

You call that support?

In a technical report on Tuesday, SwissQuote said the long-term technical pattern for GBPUSD seems ever more negative.

Long-term support given at $1.0520 from March 1985 "represents a decent target", said strategist Yann Quelenn, with more recent long-term resistance given at 1.5018 from June 2015 "and would indicate a long-term reversal in the negative trend… Yet, it is very unlikely at the moment."

For the euro, strong resistance was seen at the 0.9500 psychological level.