There are six main reasons why we remain bearish GBP:
UK economy may be about to experience a ‘once in a generation’
structural transition. A weaker GBP may be needed to ‘oil the wheels’ as
it undergoes this shift.
GBP TWI recently reached ‘all time lows’, such valuation methods become
less meaningful when economies are facing significant structural
changes like the UK is.
still give a green light to a weaker pound. Sterling’s fall did not
stop the BoE from cutting rates in August, or from suggesting it may do
so again. Until there are genuine concerns about loss of purchasing
power abroad or imported inflation, policymakers may still tolerate GBP
weakness. The market has recently started to price BoE hikes, but we
suspect a rapid drop in GBPUSD below 1.10 would be needed to warrant a
bold emergency measure from a still dovish-tilted BoE.
time, global reserve managers may increasingly reconsider holding GBP
allocations that may still be high to historical precedents. GBP no
longer provides ‘yield appeal’ is it may have done in the last few
years. Repeat ‘flash crashes’ or potential credit rating downgrade risks
make GBP a less preferred ‘reserve’ currency.
UK's balance sheet is large (relative to GDP) and leveraged
(liabilities are large and liquid vs assets), which always leaves room
for large FX moves.
are not convinced that a hard-Brexit is fully factored into market
expectations yet. The GBPUSD implied volatility curve is no longer
inverted as it would be during a true crisis, and the fact that the GBP
options market remains well functioning is itself an indicator that a
genuine hard-Brexit scenario may not entirely be factored into market
thinking. Similarly, UK 5-year CDS suggests markets are relatively
sanguine about the hard-Brexit risks. The swap is now below where it was
through most of July 2016, and considerably below 2008/09 levels.
On a 3-month horizon, we remain bearish sterling and forecast GBPUSD at 1.16 and EURGBP at 0.95.