We revised our forecasts for Sterling sharply lower in July, bringing in particular our 3-month forecast for GBP/$ to 1.20. In the period that followed, however, Cable refused to fall in line with our forecast for two reasons.
Bank of England didn’t ease in July, preferring to wait until its
August meeting. This delay, though in line with the expectations of our
UK economists, was nonetheless a disappointment for markets, and broke
what up to that point had been clear momentum to the downside in GBP/$.
immediate aftermath of the Brexit vote saw a political vacuum in the
UK, with some possibility that Article 50 might never actually be
triggered. As a result, markets began to trade the short-term data flow,
which was better-than-expected, and speculative short positioning in
Sterling was squeezed.
Prime Minister May’s announcement that Article 50 will be triggered
by March next year has changed all that and refocused markets on what we
see as one of the cleanest macro trades out there. In a sign of how
times have changed from a month or so ago, discussion has now switched
to how much downside there potentially is in Sterling, away from the
recent focus on positioning and data flow.
forecast that Sterling will fall about another 5 percent on a
trade-weighted basis in the next three months, which translates into
1.20 for GBP/$.
This forecast reflects two considerations.
see a continued catch-down of trade-weighted Sterling with longer-dated
rate differentials (Exhibit 1), which in this low policy rate
environment have become the main driver of G10 exchange rates.
continue to believe that a “sudden stop” of the kind seen in emerging
markets – when a sudden stop in capital inflows forces a large
devaluation of the currency in the face of a current account deficit –
is unlikely in the UK, given that rule of law and institutions are
stable. Exhibit 2 shows that our forecast for a further 5 percent
depreciation of Sterling roughly splits the difference relative to the
kind of devaluations that emerging markets tend to see during balance of
payments crises. That said, as our economists have highlighted, the
process of Brexit involves large uncertainty i.e., could easily turn out
to be more complicated and drawn out than expected. Risks to our Sterling forecast are therefore to the downside.