Pound Sterling Could Recover to Pre-Brexit Levels says Capital Economics, Predict Gains against Both Euro and Dollar for 2021

- GBP/USD back to pre-referendum levels
- UK stocks set to outperform U.S. stocks
- But GBP/EUR upside more limited

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• Market rates at publication: GBP/EUR: 1.1489 | GBP/USD: 1.3909
• Bank transfer rates: 1.1260 | 1.3620
• Specialist transfer rates: 1.1400 | 1.3812
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The British Pound could recover to pre-Brexit referendum levels in 2021, according to analysts at independent research house Capital Economics.

"A further improvement in global risk sentiment and a relative rise in UK interest rate expectations may mean the pound continues to strengthen," says Paul Dales, Chief UK Economist at Capital Economics.

The call comes as Sterling maintains a course of appreciation against the Dollar, Euro and a host of other major currencies, with only Norway's Krone besting it owing to the Scandinavian currency's fixation with surging oil prices.

Capital Economics say that a fundamental underpinning of Sterling's rally has been the vaccine rollout and a rapid reduction in UK covid-19 cases, which will lead to a sustainable unlocking of the economy ahead of those countries where the vaccine rollout lags.

Above: All-time chart showing GBP valuations vs. EUR

Crucially, the next unlocking will be a more permanent one: "Our assumption that vaccines mean that few COVID-19 restrictions will be required beyond June largely explains why we think the recovery in UK GDP will be faster and fuller than most expect," says Dales.

UK Prime Minister Boris Johnson is expected to announce on Monday Feb. 22 a programme for unlocking the economy, with schools expected to return on March 08.

Hospitality - a critical element of the UK economy - is expected to return to business in early April, according to leaked plans.

By contrast, Capital Economics say the slower vaccine rollout may hold back the recovery in the Eurozone.

Above: All-time GBP/USD chart

But Capital Economics say it won't just be the Pound that benefits from the covid-19 recovery, as other UK assets will see a rebound from heavily discounted levels.

"The UK’s more favourable valuations and its greater exposure to the sectors that are likely to benefit most from the recovery, such as consumer-facing, energy and financial, suggests that equities in the UK will rebound more rapidly than elsewhere," says Dales.

Researchers say a strong economic recovery in the second half of this year should help UK equities outperform those in the U.S., a development that comes after years of UK equity underperformance.

Some of this outperformance will owe itself to rising oil prices, which would suit the energy-heavy FTSE 100.

Capital Economics forecast oil prices back up to $70/barrel by the end of the year.

The call comes as the FTSE 100 starts to finally start showing some life, having risen sharply through the mid-February period, outpacing its European and U.S. cousins.

"Investors used to seeing the index lag far behind US and European peers will be cheering on as almost the entire index moves higher. Commodity and oil names are at the forefront of the surge, bolstered by another move higher in oil prices, a rally that shows no sign of slowing down, while mining stocks have been lifted by the gains in raw materials," says Chris Beauchamp, Chief Market Analyst at IG.

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Giving a potential rebound in UK assets added impetus will be the fading hangover from the EU referendum of 2016 now that post-Brexit trade negotiations have been wrapped up.

Negotiations and questions as to what the future trading relationship between the EU and UK would look like have been a source of uncertainty for businesses and investors over recent years, the lifting of this cloud of uncertainty is expected to offer Sterling and UK assets further upside.

"UK assets are well placed to shake off their underperformance since the 2016 Brexit vote by outperforming global assets over the next couple of years," says Dales.

"With a no-deal Brexit no longer hanging over it, we suspect the pound will continue to be boosted by a further improvement in global risk sentiment and a rise in UK rate expectations
relative to those in the US and the euro-zone," he adds.

Capital Economics see the potential for the Pound-to-Dollar exchange rate to rally from current levels at around 1.39 to 1.45 in 2021.

"That would take the dollar/pound rate back to within a whisker of the level seen before the 2016 Brexit vote," says Dales.

However upside against the Euro is expected to be more limited, with the Pound-to-Euro exchange rate forecast to appreciate from 1.15 to a high of 1.16.