Pound Sterling Forecast "to Feel the Burn" in 2021, Even on a Brexit Deal says HSBC

- HSBC see a lower GBP in 2021
- No Brexit deal relief rally likely
- Brexit deal could be ready next week says UK newspaper

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Forecasts for the British Pound in 2021 from HSBC reveal expectations for the currency to decline, even in the event of the UK and EU achieving a post-Brexit trade deal.

The view from the UK's largest bank flies in the face of consensus in the analyst community which says the Pound will rally against the likes of the U.S. Dollar and Euro over coming months, provided a deal is reached between the EU and UK before the year-end cut-off.

"We maintain a counter-consensus view on GBP, and expect the currency to weaken from current levels," says Dominic Bunning, Head of European FX Research at HSBC Bank plc. "We doubt that recent GBP resilience can last".

HSBC analysts tell clients there are two deteriorating dynamics specific to the UK that will make for a weaker Pound:

1) Trade frictions will rise: If a deal is agreed this year, the UK still faces greater costs of doing business with the EU, which is the country's largest trade and investment partner.

"Even with a Free Trade Agreement, increased costs in the form of “non-tariff barriers” will be sizable – by up to 14% based on UK Treasury analysis. A no-deal outcome would see even bigger barriers to doing business. GBP-USD does not appear to be factoring this in given it is trading close to its historic long-term fair value. In our view, the currency is the most likely channel through which an adjustment could be delivered to offset the impact of the greater costs," says Bunning.

2) The economic rebound from the covid crisis is faltering: The UK economy has been severely impacted by the coronavirus crisis, moreso than many of its global G10 peers.

"The UK saw the largest negative growth shock in Q2 amongst G10 economies and now faces a slower pace of recovery, in our view. Earlier upside economic surprises already look unsustainable and are rolling over as greater restrictions are imposed on activity. A lack of policy flexibility suggests diminishing government support compared to Q2 and Q3," says Bunning.

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Given the headwinds, the value of the Pound must decline in value to entice international investors to divert capital into the country.

"A softer currency can help to offset the relative negative performance of the UK’s cyclical rebound versus its peers. And from a longer-term perspective, the drag on the UK economy of putting up greater barriers to economic activity will ultimately exert a drag on GBP. A 5-10% discount as implied by our end-2021 forecast of GBP-USD at 1.25 is modest in this sense," says Bunning.

Should the EU and UK fail to reach a trade agreement, HSBC analysts warn a much more significant discount to 'fair value' of around 20-25% would be likely, at least in the short-term, pulling GBP/USD down to 1.10 and the GBP/EUR exchange rate down around parity.

"Sterling is set to feel the burn, deal or no deal, in our view," says Bunning.

HSBC are forecasting the Pound-to-Dollar exchange rate to trade at 1.30 by year-end - a significant upgrade from previous forecasts of 1.20.

The pair is seen at 1.25 by mid- and end-2021.

The Pound-to-Euro exchange rate is forecast to trade at 1.11 by year-end 2020, a substantial upgrade from the previously-held forecast of 1.04. By mid-2021 the pair is seen at 1.09 where it is estimated to be by year-end 2021.

Brexit Deal Possible Next Week, (or Year-end)

The UK and EU could sign a post-Brexit trade deal as early as next week, according to reports. However, contradictory briefings suggest negotiations can really run down to the wire and that the real deadline envisaged by the EU is December 31.

The UK's Chief Negotiator in EU-UK trade talks has apparently told UK Prime Minister Boris Johnson to be prepared to agree to a trade deal "early next week", according to The Sun.

The report says David Frost has told Johnson a "possible landing zone" could be ready by Tuesday.

Pound exchange rates have shown little reaction to this headline, hinting at a deep sense of caution amongst market players. However, the potential for a sizeable rally or drop in the Pound is said to be growing. "GBP looks poised for a big move as Brexit enters its crunch phase," says Andrew Spencer, a Reuters market analyst.

"At this point, I think I've seen 'sources' reports say that a Brexit deal could come any day between Thursday and next Tuesday, essentially seems that a deal is close, but nobody knows when it might happen...no real change from the start of the week in that case," says Michael Brown, Senior Market Analyst at CaxtonFX.

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Thursday's European Council telephone meeting of EU leaders is therefore not a realistic deadline, as had been the assumption for some months now. Instead, political commentators and reports believe the meeting will allow the EU to alter the mandate given to their chief negotiator, Michel Barnier.

While a deal by next Tuesday would present an early Christmas present for those looking for an end to the years of negotiation, caution is urged.

It was reported on Monday that the EU have all but conceded that the real deadline to talks is New Year's Eve, when the transition period is due to run out. The European Commission has said they would find a "creative solution" in order to facilitate a deal as typically the EU Parliament would need to assess, and then vote on, a deal.

European Commission President Ursula von der Leyen said she is more interested in the "quality" of the deal than the "craziness" of deadlines.