We are skeptical about the British Pound rally: UniCredit

The British Pound Sterling (Currency:GBP) is currently holding onto the strong gains recorded over the past 24 hours:

• The Pound to Euro exchange rate is 0.06 pct lower than seen at yesterday's close, GBP-EUR is at 1.1609.

1. The Pound to US dollar exchange rate is 0.12 pct higher at 1.5508.

Please Note: The above quotes are taken from the wholesale spot markets. Your bank will charge a discretionary spread to the rate when passing on their retail rate. However, an independent FX provider will guarantee to undercut your bank's offer, thus delivering you more currency. Please find out more here.

UniCredit Bank: "We feel highly skeptical about the sustainability of the GBP rally"

Dr. Vasileios Gkionakis gives the following analysis of recent GBP price action and warns that the rally is built on shaky foundations:

"Over the last few weeks there has been a number of data releases and events that have influenced considerably the price action in sterling.

For starters, several upside surprises in UK data (PMIs and IP, in particular) have raised hopes about the recovery and have provided support in GBP-USD.

Yesterday's announcement of the details on forward guidance by the BoE although led initially to a weakening of cable, in the course of the day it resulted in higher yields and a much stronger GBP-USD, which reached as high as 1.5531 before retreating slightly back towards 1.55 today.

Although our assessment of the BoE's forward guidance language was that it was quite dovish, the market seems to have taken the opposite view: this could be because of inflation concerns and the poor track record of BoE in forecasting inflation (in other words, the market may think that it is more likely that the first "knockout" clause – projected inflation above 2.5% - is hit); or because it was expecting a lower unemployment threshold (possibly in the vicinity of 6.5%); or even because it may have taken the view that the 7% unemployment threshold will be reached sooner than the bank anticipates.

Although we do acknowledge the improvement in UK data, we feel that a sustained rally above the 1.55 level is unlikely in our view.

Firstly, the recent raft of data surprises might have raised the bar for future surprises in order to remain supportive of sterling. Given that we still view the recovery as very fragile we think it is more likely than not that future data releases will fail to provide that sort of support to the currency.

Secondly, current account balance dynamics are particularly unfavorable for sterling. Although C/A balances do not have an exceptionally good record in forecasting currency moves in the short-to-medium term, we feel that the divergence of C/A balances between the UK and the US and especially the euro area are quite stark at the moment and markets seem somewhat complacent about this.

Thirdly, if the market is right about its inflation concerns, this should actually work against the currency and not in favor of it. If relative inflation differentials between the UK and the US and the euro area deteriorate (meaning that inflation in the UK rises faster) this should erode further UK's international competitiveness and actually weigh on sterling.

Furthermore, implicit to the state-contingent forward guidance by the BoE is the desire to keep long rates stable, or indeed lower, in an attempt to safe guard the fragile state of lending channels. If it fails to do so, we think that the central bank will be forced to take more aggressive action – probably in the form of additional asset purchases – something which should also pose an additional headwind for sterling.

All in all, we feel highly skeptical about the sustainability of the GBP rally and think that the odds are for sterling weakness in the medium term. One risk to our call is that growth dynamics pick up faster than we foresee; but we still feel that the more robust growth momentum in the US, the upcoming tapering of QE and the subsequent steeper US yield curve will boost the USD more, weighing eventually on GBP-USD. Hence, we remain comfortable with our year-end forecast of 1.50.