Pound Sterling to Lag Euro into Year-end as Brexit Gridlock Weighs, but Gains vs. Dollar Possible says Investment Bank

Above: Front-runner to replace Theresa May, Boris Johnson. Image © Andrew Parsons/ i-Images, Accessed Flickr, license: Creative Commons

- Political "chaos" to see GBP lag other G10s into year-end says TD Securities

- Brexit gridlock to become increasingly heavy burden for economy

- GBP eyes shallow climb against USD but more losses against EUR

- Forecasts come as Boris Johnson set to win Tory leadership vote.

The Pound is trading near multi-week lows against the Euro and U.S. Dollar on Thursday, July 04, and we are told the currency is set to remain an underperformer into year-end by global investment bank TD Securities who note a combination of unfavourable economic developments and chronic political uncertainty in the United Kingdom.

The UK currency is projected to end the year lower against the Euro, but against the U.S. Dollar a potential recovery could shape up, however any gains in GBP/USD will largely be down to expectations for a broad turn lower by the big Dollar.

For Sterling, it could be a case of 'bumping along the bottom' as political uncertainty combines with increasingly unfavourable economic fundamentals.

"Growth dynamics are all over the map right now,"  says Mark McCormick, head of FX strategy at TD Securities. "We expect negative growth in Q2, even on a rebound in May GDP, and with a risky global backdrop, the Bank of England is likely to remain on hold now through all of 2019 and 2020, even if domestic cost pressures continue to rise on the hot labour market and inflation remains near target,"

This week has seen UK economic survey data suggest the economy cooled notably in June with Manufacturing and Construction PMI data suggesting these two sectors are now contracting, while the Services PMI reading of 50.2 suggests the UK's largest economic sector is barely growing.

The combination of a slowing domestic economy, global economic risks related to U.S.-China trade tensions and Brexit uncertainty meanwhile prompted Bank of England Governor Mark Carney to sound a warning that the case for further central bank intervention is "broadening": markets took this as a strong hint this week that interest rate cuts might be required in coming months.

The Pound fell on the comments.

Above: Sectoral contributors to changes in monthly GDP growth in UK. Source: TD Securities.

TD Securities says the broad mix of pressures will keep the BoE on the fence until after the end of next year and that as result, Pound Sterling will see its recovery potential capped as a result.

Changes in interest rates impact currencies because of the push and pull influence they have over capital flows: capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. 

Chronic Political Uncertainty

"The UK's political chaos continues to dominate traditional fundamentals. The mixed macro backdrop adds to the uncertain GBP outlook. Leadership transition will provide only temporary relief, if any," says McCormick.

Downbeat views on the Pound's outlook come as former foreign secretary Boris Johnson remains in poll position to win the Conservative Party leadership race ahead of current Foreign Secretary Jeremy Hunt. 

Both candidates have Brexit as the centrepiece of their campaigns with both warning that unless the EU agree to an improved Brexit deal they are willing to take the UK out of the EU without a deal on October 31.

Growing expectations for a 'no deal' Brexit have in turn prompted a sharp decline in Sterling against both the Euro and U.S. Dollar over recent weeks.

Grassroots members of the Conservative Party will through the course of July vote for their next party leader, who'll become Prime Minister by default, with the result expected on the 23rd or soon after.

The Brexit positions of both candidates as well as fluctuating odds of a 'no deal' Brexit will therefore remain the most prominent drivers of Sterling exchange rates during the summer period.

"The new PM will face old challenges. In the absence of fresh developments, we think cable will broadly track other regional currencies, but its performance could lag overall. That said, EURGBP has had an extended 'overbought' run, suggesting some chance of a pullback on any positive developments," says McCormick.

Forecasts for the Pound

The British currency is set to end the year lower against the Euro, but 'oversold' conditions against the Eurozone's single-currency suggest the Pound-to-Euro exchange rate could experience a short-term rebound over the summer months which should offer a window of opportunity for those readers looking to transfer Sterling into Euros. 

The Pound-to-Euro exchange rate is forecast to trade at 1.1235 by the end of September, before falling back to 1.11 in time for year-end, suggesting that window of opportunity will in all likelihood be brief.

However, the potential for a recovery against the U.S. Dollar exists as TD Securities believe the Federal Reserve has set the course for lower interest rates, which should weigh on the Greenback going forward.

"The Fed's pivot has taken the wind out of the USD's sails. The race to the bottom is now in full force and the Fed has a considerable advantage with a much longer policy runway. Though the USD still retains a yield advantage over much of its peers in the G10, we think the USD, on balance, remains destined for a course correction lower," says McCormick.

McCormick forecasts the Pound is likely to end the third-quarter at 1.29 against the Dollar before climbing to only 1.30 by year-end and 1.32 before the end of 2020.

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