British Pound Forecast: Citi Warn a Brexit Deal Won't Bring any Major Recovery vs. Euro and U.S. Dollar

Image © Goroden Kkoff, Adobe Stock

- Pound Sterling could benefit from a vote of confidence in P.M. May

- Citi forecasts show Sterling to remain capped by political anxieties

- Another year of sideways action forecast for GBP/USD and GBP/EUR

Expect the British Pound to trade in subdued fashion over coming months.

This is the message from the world's largest foreign exchange dealer, Citi, who eye further tricky Brexit negotiations ahead but say a deal should be expected by investors.

Unfortunately for Sterling bulls, Citi's forecasts show that the promised Brexit deal will not yield the huge gains for the Pound many are assuming.

"Notwithstanding the conciliatory statement from the E.U. on Brexit this week, the main stumbling block (the Irish backstop) still remains in place with the E.U., and Irish Government still insisting that a Northern Ireland-specific backstop remains in place, even if a separate UK wide customs arrangement is negotiated," says a note to clients of Citi's wealth management division.

"GBP/USD and EUR/GBP see a brief respite but not surprisingly, markets are quick to fade subsequent GBP strength on the realisation that the inability to resolve the Northern Ireland border issue will only cause more angst for staunch Brexiteers in PM May's cabinet," add analysts.

Citi note the Brexit stalemate continues and their foreign exchange strategists reckon there remains a very real (and growing) risk that the UK exits the E.U. in March 2019 with no transition agreement in place.

However, their base-case assumption is that a deal is reached, "eliminating uncertainties in the long run."

Despite expectations for a deal and faded uncertainties, Citi forecast the Pound-to-Euro exchange rate to trade at 1.1235 in three, six and 12 months suggesting another year of sideways action.

The Pound-to-Dollar exchange rate is forecast to trade at 1.33 in three months and 1.26 in six to twelve months.

This places Citi more-or-less in line with consensus forecasts. For a look at where 50 of the world's leading investment banks are forecasting Sterling we recommend downloading a report on the matter from Horizon Currency Ltd. The report includes targets set by the likes of Goldman Sachs, HSBC, Barclays and Morgan Stanley. The GBP/USD report is here, the GBP/EUR report here.

However, Citi's forecast for more sideways action in Sterling is not shared by other analysts, particularly technical strategists such as Trevor Charsley at AFEX.

This week saw Charsley tell clients, "studies suggest this re-consolidative pattern is gradually narrowing/maturing and enough compression already exists to enable a significant break-out going forward."

Of particular interest is a breakout in the GBP/EUR exchange rate which has been hugging the 1.1250 area.

"An extension above the previous 1.1600 cycle peak remains necessary to suggest an improvement in underlying GBP fortunes," says Charsley.

Seperately, analysts at ANZ Research have told clients they expect Sterling to retain a weak bias over coming weeks.

"GBP retains a weak undertone," says Daniel Been, Head of FX Research at ANZ.

While U.K. economic activity is seen holding up relatively well, ANZ acknowledge Brexit risks are the only focus for markets.

"So the data can’t add any conviction to market expectations that the BoE may follow up its latest rate increase any time soon. Brexit headlines emerge daily, but short of real progress (or a ‘no deal’), they are unlikely to trigger a decisive directional shift in Sterling," warns Been.

A Potential Positive Trigger for Sterling: A No Confidence Vote in May

Domestic political risks remains a key driver to near-term moves in the Pound with markets showing nervousness as to the longevity of Prime Minister Theresa May's hold on power, fears we believe are misplaced and could in fact work to Sterling's advantage.

We heard this week that May's showdown with her parliamentary party went well; we always felt that this was a case of 'much ado about nothing', particularly from a currency market perspective.

There remain lingering concerns that May might face a vote of no confidence if a threshold of 48 MPs express they have lost confidence in the Prime Minister. A vote of confidence would have to be called if the threshold is met and if May loses this vote she is out and a replacement must be found.

This would be incredibly negative for the British Pound as it introduces a huge dose of uncertainty just as Brexit negotiations enter their most crucial phase. It would significantly ramp up the prospects of a 'no deal' Brexit and this fear is one reason why Sterling is lower than where it could potentially be.

We believe these fears are misplaced.

Firstly, 158 Conservative party MPs would have to vote against May to oust her, this is just over half the Conservative party representation. The rebels have been struggling for over a year now to muster up a mere 48 letters of no confidence; we see almost nil chance of the sea-change required to jettison her happening anytime soon.

If anything, we think a vote would be good for Sterling as May will survive it and Conservative party rules state that another vote can be mounted for a year.

It would therefore put to bed this domestic uncertainty and allow Brexit negotiations to proceed and remove a lingering source of uncertainty that has been hanging over Sterling valuations for months now.

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