GBP: Volatility Ahead? - Rabobank
Jane Foley, Research Analyst at Rabobank, notes that the Bank of England
Governor Carney yesterday defended the warnings over a Brexit that were
contained in the Bank’s policy statement last week.
Key Quotes
“The Bank has suggested that on a Brexit “households could defer
consumption and firms delay investment, lowering labour demand and
causing unemployment to rise. At the same time, supply growth is likely
to be lower over the forecast period, reflecting slower capital
accumulation and the need to reallocate resources.
Sterling is also likely to depreciate further, perhaps sharply. This
combination of influences on demand, supply and the exchange rate could
lead to a materially lower path for growth and a notably higher path for
inflation than in the central projections set out in the May Inflation
Report.” The stark warnings only had a temporary impact on EUR/GBP but
they had a significant impact on the ‘Leave’ campaign with MP Rees-Mogg
accusing Carney of being highly pollicised in what was meant to be an
impartial role and calling for him to be fired.
It is clear that the remaining 38 days until the June 23 referendum on
EU membership promise to be politically highly charged. This suggests
there is plenty of scope for sterling volatility to increase. Since the
start of the month cable has pushed lower. This, however, is in tune
with the broad-based improvement in the tone of the USD over the same
period. Despite the uncertainties over Brexit, EUR/GBP has been
relatively steady in May compared with recent months. This suggests that
investors may consider themselves to be well positioned ahead in case
of a Brexit. Alternatively there may some complacency within the market
regarding the prospect of a continuation of the status quo after the
referendum.
If there is a vote favouring Brexit next month, we expect that political
uncertainty will trigger a sharp move higher in the value of EUR/GBP
towards the 0.86 region. On a ‘Remain’ vote we see scope for a relief
rally in sterling towards EUR/GBP 0.75.
The extent of the pound’s move in the coming months will be a crucial
determinant for BoE policy. The weakness of economic data this year have
made it clear that UK growth is slowing. For this reason we expect that
even on a ‘Remain’ vote that sterling will not be able to recover to
its November highs this year. On the back of softer UK data releases we
have pushed out our expectations for the first BoE rate rise of the
cycle to May 2017 at the earliest. This call, however, assumes the UK
stay within the EU. A softer pound does increase inflation potential.
However, this will not automatically lead to a tightening in BoE policy
if concerns about slowing growth are significantly greater. The sterling
outlook is currently dependent on a great many variables and we would
expect to see greater volatility in EUR/GBP in the coming months. This
week UK’s CPI, labour and retail sales data releases will bring extra
interest.”
