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.
“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.”