Pound Sterling Forecasts vs. Euro, Dollar from Deutsche Bank: Rough Summer, Higher by Year-End

© Deutsche Bank  

- GBP is worst performing major currency this May

- May exit viewed as key risk to Sterling. 

- Market to fear Oct 31 'Brexit at all costs' through summer.

- Possibility of election and Corbyn government to also weigh.

The British Pound is set to rise from current levels before the year is out but not before it receives a drubbing over the summer as the political circus in Westminster leads investors and financial markets to increasingly prepare for a UK exit from the EU on World Trade Organization (WTO) terms say foreign exchange analysts with global investment bank Deutsche Bank.

"Remarkably, given a truly chaotic political backdrop, Sterling has been the best performing G10 currency year to date. The market has largely looked through the
unfolding Brexit saga. We don't think such strong performance can continue," writes Oliver Harvey, a strategist at Deutsche Bank, in a note to clients.

Deutsche Bank analysts have written to clients saying they expect Pound Sterling to trade in volatile fashion over coming weeks given the current state of voting intention opinion polls, which put support for the governing Conservative Party in the single digits with less than one week before the European parliament elections.

Riding high in first place in all of those polls is The Brexit Party which sprung from the political ether less than two months ago and, headed by arch eurosceptic Nigel Farage, is expected to easily win the European elections.

The support for the Brexit Party also appears to be translating into Westminster voting intentions, with a YouGov poll saying the two main parties the Conservatives and Labour would only poll 24% apiece were elections to be held now, ahead of the Brexit Party which would poll 18% alongside the Liberal Democrats.

The rapid fall in support for the Conservatives is expected to galvanise the party into adopting more robust stance on Brexit.

"Polls suggest a dismal performance for the Conservative Party as its vote share is cannibalised by the new Brexit Party, with the latter also overtaking the Tories in the latest round of general election polls. As a result, there is a strong chance Prime Minister May is pushed out in coming weeks by her MPs. We think the next Conservative leader would adopt a far harder Brexit stance," Harvey writes.

Currency traders are concerned are that the Conservative Party could be forced to pivot toward a "Brexit at any cost" strategy, in order to save itself from electoral oblivion, that sees the UK leave the EU and default to doing business with it on World Trade Organization terms.

"The Conservatives are expected to perform very abysmally in the EU elections while the logical consequence should be further pressure on Theresa May. Her successor, probably Boris Johnson, would sell his own grandmother to deliver Brexit as fast as possible," says Marc-André Fongern, a strategist with MAF Global Forex in Frankfurt.

This raises the prospects of a 'no deal' Brexit, and explains the Pound's recent underperformance.

Many parliamentarians are opposed to a 'no deal' exit and some have threatened to bring down the government if it attempts to pursue one but opposition to PM May's deal - one of only two things that can prevent it at this stage - remains high in the House of Commons.

"This in turn could alienate moderate MPs and lead to an early election. Unless a Brexit deal is ratified imminently, the market faces a choice between a crash Brexit in October or a market unfriendly Labour policy mix," Harvey warns.

Above: Pound Sterling performance against the major currencies over the course of the past week. Source: Pound Sterling Live. 

Finanical markets fear a Labour Party government as much as, if not more than, a so-called no deal Brexit because of the Marxist ideology and anti-market policy platform of opposition leader Jeremy Corbyn. He's repeatedly pledged vast increases in spending that risk the post-crisis work done on repairing the public finances.

Labour has also pledged to nationalise energy companies in an effort to reduce household costs, but at great cost to the public purse and also, potentially, to investors.

Party officials have repeatedly failed to provide clarity on whether investors would be sufficiently compensated for their assets. That might simply be result of a desire to avoid encouraging a ramp-up in the price of energy company stocks, but it might also suggest an openness to foul play.

"Much of the portfolio inflows into the UK over the last four quarters are repatriations of foreign assets rather than inflows. These in turn have been due to domestic investors rebalancing portfolios after gains on global equities. If stocks sell off due to a worsening China/US trade war, repatriation flows should reverse. Sterling thus has a high sensitivity to a weaker risk environment," Harvey warns.

Chicago Futures Trading Commission data, and internal Deutsche Bank data, suggest that so-called short-sellers abandoned bets against Pound Sterling a while ago. In fact the amount of speculative money that is betting on an increase in value has recently reached a three-year high.

Forecasts for the Pound

There's now a serious risk that all of those investors who've been backing the Pound over recent months are forced to abandon their bets as the currency comes under pressure due to political uncertainty. And if they do they will simply add to further to the bucket-loads of Sterling that might be dumped on markets over coming months.

"A nice way to play Pound weakness is via the yen. This benefits from both relative positioning, valuation and its high beta to global risk aversion should the trade conflict escalate further. We target 135 in the cross," says Harvey.

Deutsche Bank is looking for the Pound to fall relative to the Japanese Yen in the short-term, but the German lender is still forecasting a strong finish to the year for the Pound-to-Euro and Pound-to-Dollar exchange rates.

They are looking for the Pound-to-Euro exchange rate to rise to 1.20 before year-end and for the Pound-to-Dollar rate to hit 1.40, as their ultimate expectation is that a disorderly Brexit will be avoided.

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