Pound Sterling to Hold Steady Vs Euro and Rise Over the Dollar in 2018 Say Intesa Sanpaolo

Growth will be slower in 2018 than in prior years but, if the economy remains stable and Brexit talks evolve constructively, Sterling will benefit.

The Pound could hold its ground against the Euro in 2018 and rise against the US Dollar, according to strategists at Intesa Sanpaolo, although they note that the risks are slanted to the downside.

If the economy remains on a steady footing and the Brexit negotiations evolve toward an amicable agreement covering trade and transition, the chances of another interest rate rise from the Bank of England will increase.

Hopes of another hike from the BoE would be enough to ensure that the darkest days have passed for Sterling, while providing the currency with a chance of taking back some lost ground in the year ahead.

“Barring a significant deterioration of the macro picture, last year’s lows should now have been overcome, against the dollar in particular, but maybe also against the euro as well, as the size of the correction incurred in 2016 also reflected the risk of the worst-case scenario materialising,” says Asmara Jamaleh, an economist at Intesa Sanpaolo.

The economy has slowed in 2017, with quarterly growth halving to 0.3% in the first and second quarters, while only rising to 0.4% in the third-quarter.

Although this was less than initially feared in the aftermath of the 2016 referendum, the slowdown has been a headwind to a recovery of the Pound.

The Bank of England’s hawkish turn in September and its decision to raise interest rates in November have helped to put a floor beneath the currency although its fate in 2018 will be determined equally by what happens to the economy and developments in the Brexit talks.

“In any case, after the weak patch incurred in the first half of this year, the economy should be fuelled by the global recovery and by the past depreciation of the exchange rate, which should support foreign trade,” Jamaleh adds.

The Bank of England suggested in its latest statement that the economy may draw support from some of the measures announced in the November budget, which may add 0.3% to GDP during the next 2-3 years, mostly due to a slower pace of belt-tightening by the government.

“The implications for the interest rate path, after the hike implemented in November (from 0.25% to 0.50%) to counter the rise in inflation, point to an extremely gradual succession of upward moves, indicatively one a year in the next two or three years,” says Jamaleh.

The Intesa Sanpaolo team flag Bank of England forecasts for a modest pickup in growth next year, to be followed by a further acceleration in 2019, as additional grounds for thinking a further slowdown is unlikely in the coming quarters.

“Although this means that the economy will slow compared to the past few years as a result of Brexit, the slowdown will be relatively contained when considering the size of the structural change implied by exiting the European Union,” the strategist writes in a recent note.

Progress toward a trade deal will be the crunch issue for Sterling as, without this, the UK could face a so called “hard Brexit”. This is a “no deal” Brexit where the UK departs the EU without an agreement on future trade but the Bank of England’s forecasts are contingent a “smooth Brexit” from the EU.

Prime Minister Theresa May is seeking an agreement that leaves the UK with preferential access to the European Union single market, in a greater sense than other third countries have.

“This is an ambitious aspiration on the UK’s part, and will be the key market theme for most of next year, as – taking for granted that, at least in the near term, exit from the EU will have negative repercussions on the British economy – the better the terms the United Kingdom will manage to secure, the smaller the negative fallout on the economy will be,” says Jamaleh.

The ebb and flow of changing negotiating positions, and consequent speculation, will be a major source of volatility for Sterling in the year ahead. Much like it has been in already 2017.

“If data do not disappoint, and generally confirm the BoE’s growth and inflation outlook, and assuming the United Kingdom manages to sign a “good” deal with the EU, sterling should be in the position to stabilise and, against the dollar at least, to strengthen slightly over the course of next year, towards GBP/USD 1.38 by the end of 2018,” says Jamaleh.

“Against the euro, a stabilisation around the EUR/GBP 0.86-0.88 range should prevail, rather than a strengthening, due to the simultaneous appreciation of the EUR/USD.”

The Pound was quoted 0.01% higher at 1.3385 against the Dollar during early trading Wednesday while the Pound-to-Euro rate was marked 0.04% lower at 1.1302.

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