Pound Sterling Forecasts Slashed at Bank of America

- Deep cuts issued on GBP at Bank of America
- UK economy set for sizeable reset
- Even a Brexit trade deal won't stop the bleed

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Foreign exchange analysts at Bank of America Merrill Lynch Global Research have issued fresh downgrades to their British Pound forecasts, saying the economy is on the cusp of another major reset in the face of the dual shocks of covid and Brexit.

"We maintain our bearish view on GBP and have made downward revisions to forecasts," says Kamal Sharma, FX Strategist at Bank of America Merrill Lynch.

In a previous assessment of Sterling made in June, BofA told clients they saw Sterling as having transformed into an emerging market currency, due to heightened volatility in the four years following the 2016 Brexit referendum that left it resembling the Mexican peso rather than a reserve currency such as the U.S. Dollar.

The sharp downgrades and bearish tone continues with the bank's July update on Sterling, that comes as EU and UK trade negotiations continue to inch forward with no indication of an imminent breakthrough and the economy continues to operate below full capacity.

"Heading into August, we think the rest of 2020 is a harbinger of further weakness to come," says Sharma, who says one source of weakness will be seasonality as his research shows the August-December period is historically a negative period for Sterling performance.

This expectation is cemented by the twin headwinds of Bank of England policy that could see negative interest rates being introduced as well as a 'no deal' outcome to current EU-UK trade negotiations.

"The fortunes of the pound will increasingly be driven by the monetary policy stance, the ability of the economy to rebound from the global pandemic, and Brexit negotiations, which are effectively stuck in the mud," says Sharma.

Above: The average monthly performance of the Pound measured on a trade weighted basis since 2004.

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The call for further Sterling weakness comes as the Pound continues to endure weakness during 2020 with only the Norwegian Krone and Canadian Dollar losing ground to Sterling, however the U.S. Dollar and New Zealand Dollar only currently holding gains of 2.0% and 1.0% respectively.

The Pound has seen its performance improve through July, with the declines seen in the post-April period fading and in many instances giving away to gains. For instance, over the course of the past month Sterling has gained 4.0% against the Dollar, 1.75% against the yen, 2.30% against the Canadian Dollar and 1.0% against the New Zealand Dollar.

We note that sentiment towards the post-covid economic recovery in the UK has improved somewhat, suggesting the UK won't be the laggard markets had been anticipating with PMIs and other survey data suggesting the recovery accelerated in July.

Furthermore, we note that while expectations regarding a trade deal with the EU remain subdued talks are by no means in a terminal trajectory. Indeed, months of intensive discussions and contacts between the two sides have meant the two sides continue to inch closer. EU Chief negotiator Michel Barnier last Friday told EU ambassadors that, “I remain confident that a balanced and sustainable deal remains possible, even if less ambitious."

A deal by October therefore remains a base case assumption by many in the analyst community.

But Sharma says that even with a deal, the UK's economy will undergo a reset as the relationship with its most important trading partner will have experienced a substantial shift.

"Our base-case scenario remains that a deal will be agreed before the end of the transition period," says Sharma. "For our call on GBP, what matters is not whether a deal will be struck, but the substance of that deal. We think the market has gone past a simple binary choice of deal = positive GBP, no-deal = negative GBP. Even if a deal is reached, it is likely to be a bare-bones, skinny deal that implies the reintroduction of non-tariff barriers."

BofA analysts expect a 'no deal' to have a sizeable impact on Sterling, resulting in the Pound-to-Dollar exchange rate sinking back to 1.10 and below 1.05 in the Pound-to-Euro exchange rate.

A "bare-bones trade deal would mean a bleed lower in GBP over the course of 2021. This is the scenario that forms the basis of our forecast profile," says Sharma.

Pound-Euro is forecast to end 2020 at 1.0870, ahead of a decline towards 1.0750 by mid-2021. Previously analysts had seen the pair end 2020 at 1.15 where it would ultimately remain towards the middle of next year.

The Pound-Dollar exchange rate is forecast to end 2020 at 1.17, ahead of an anaemic recovery to 1.18 by mid-2021. The pair was previously expected to recover to 1.34 by year-end and 1.37 by mid-2021.