Pound to Dollar: This 'Conviction Call' for Further Down-side is on the Money

Westpac's strategic call to sell the GBP to USD pair on anticipation of a deep decline has proven right so far and there is still further to go before the initial target is met.

It is not too late to ride the GBP/USD train to lower levels.

The exchange rate is forecast to weaken to below 1.4000 in the run-up to the EU Referendum, in the view of analysts’ Callow, Rennie, Franulovich and Song, of Australian lender Westpac, who have issued a high conviction call that the pair will weaken in the weeks before the EU referendum.

At the time of writing the train has picked up a handy head of steam with sterling knocking on the trap door that is 1.40 following a hefty bout of mid-week selling.

After bottoming and going sideways for the greater part of March, the pair is now expected to move  sub-1.40 as mounting uncertainty caused by the approaching Referendum adds its weight to other negative factors, including falling government bond yields and, “a large external deficit.”

Westpac’s team expect the pair to fall even in the event that polls begin to show a lead for the “Bremain” campaign.

They advocated selling GBP/USD at 1.4450 with a stop at 1.4610, as “a return to sub-1.40 looks imminent.”

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So far the trade has delivered an 8.76% return.

Brexit Premium Insufficient

The pound has already lost over 8.0% against the dollar as a result of Referendum fears, according to estimates fromresearch carried out by Italian bank Unicredit.

While this is a substantial amount, analysts at Dutch lender ING, believe it is not ‘enough’ when compared with the losses to the pound caused by uncertainty in the run up to the Scottish Referendum and some General Elections.

“Looking back at how much risk was priced into GBP ahead of the 2014 Scottish referendum, and then the 2015 UK general election, we feel that a larger risk premium is required in GBP crosses now. The firming of Brexit risks should keep EUR/GBP above 0.80.”

Applying the same principle to GBP/USD’s current rate as to EUR/GBP’s in the quote above, and you get a cap on further upside above the 1.4458 highs.

April Seasonal Effect

The April pro-sterling seasonal effect is expected to keep GBP steady in the next month according to an alternative view from analysts at Bank of America Merill Lynch.

Once seasonal effects dissipate, however, they expect Brexit risks to weigh as the election data gets closer, increasing volatility in May and June:

“We believe that this will merely delay what we see as renewed pressure on the pound heading into the Referendum. With headline polling still suggesting a close contest, we believe that investors will view the event with a great deal of trepidation. FX volatility is therefore set to remain elevated at the front end of the curve as we approach June 23rd.”

They expect the pound to mount a meaningful rebound in the wake of the event as the ‘stay’ vote is set for a victory over ‘leave’.

Following the win, the upside readjustment for the pound is expected to be considerable as the over 8.0% losses from Brexit fears alone, are reimbursed almost immediately.

UK government bond yields - or Gilts as they are known - may also see a volatile rise in yields, as they have stagnated due to investors waiting for the referendum to clarify future uncertainty. They will probably see a sharp spike as interest rate expectations increase on the back of a heightened expectations that the Bank of England will raise interest rates soon, following recent improving growth data.