GBP/USD Forecast Below 1.10, but no New Record Lows says BMO Capital

• GBP/USD marks five successive daily gains
• But rally is short-term in nature
• Dip below 1.10 likely again says BMO
• Kwarteng's tenure as Chancellor will be a short one

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Poor market liquidity and low investor confidence amongst investors are to keep the British Pound under pressure against the U.S. Dollar, says BMO Capital Markets.

In a new analysis, BMO says the recent rebound in the value of Sterling will ultimately prove temporary and markets will reposition for a return lower, although a retest of last Monday's historical lows are unlikely.

The call by BMO comes as the UK currency records five successive daily gains against the Dollar amidst a rebound from last week's historic lows.

"The currency has started the week on a firm footing. Last week's BoE intervention in the gilt market and a partial reversal of the drag on the public finances this morning have kept GBPUSD above 1.10 by lifting market sentiment," says Stephen Gallo, Head of European FX Strategy at BMO Capital.

The UK Pound fell sharply after Chancellor of the Exchequer Kwasi Kwarteng announced a series of tax cuts on Friday, September 23.

It wasn't the tax cuts per se that markets were at odds with; rather it was the nature of their delivery and a cavalier approach to fiscal policy that appears to have spooked markets.

Encapsulating this approach was the surprise announcement that the 45p income tax threshold would be removed.

But Kwarteng announced Monday this decision would be reversed.

The Pound had steadily climbed through the previous week but news of the u-turn spurred it sharply higher, to the extent it is now above where it was heading into Kwarteng's fiscal event.

But Gallo says the strength is likely to be short lived and his reading of the situation is Kwarteng might soon be replaced.

"We also think the FX market has come to terms with the fact that the current UK finance minister may not be in his post for much longer, though the final outcome on this seems completely up in the air," says Gallo.

"The main point is that there can be little if any positive resolution to the near-term level of political upheaval in the UK — and that is just the political side of the equation," he adds.

Further concerns for the Pound come amidst the Bank of England's recent decision to intervene in gilt markets.

"The BoE's intervention in the gilt market purely increases the level of liquidity in the banking system, but provides little direct stimulus to the real economy. This is more 'money printing' of a currency with an inflation rate that is basically in double-digits," says Gallo.

Above: GBP/USD at 45 minute intervals. Set your free FX rate alert here.

The yield on UK government gilts surged in the wake of Kwarteng's fiscal event, which created stresses for elements of the pensions industry.

But a decision by the Bank of England to buy certain types of bonds ultimately forced a reversal in these yields.

Analysis from Credit Suisse found that had the Bank of England not intervened, and pension funds went bust, the Pound-Dollar exchange rate will already have fallen below parity.

Meanwhile Gallo says the backdrop of stagflation in the UK (elevated inflation amidst low growth) "is pushing up risk premia (i.e. liquidity preference), and this may force the government to rely more heavily on shorter maturity debt issuance".

Gallo says recent price action in the Pound suggests liquidity remains very poor, leading him to believe that poor liquidity has been a key driver of the rebound.

"As for the fundamentals, we think most of the 'good news' related to the government's reversal on unfunded fiscal policy loosening is in the price," says Gallo.

BMO Capital's one- to three-month forecast sees the Pound to Dollar exchange rate trade to levels sub-1.10, "but not to new lows," says Gallo.