Nomura: Pound Sterling Can Still have a Good 2021 against Euro and Dollar

- GBP to benefit from 'return to normal' trade
- Vaccine rollout could aid GBP sentiment
- Nomura long GBP/USD

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Despite a lacklustre start to 2021 for the British Pound further downside is expected to be limited, according to a leading foreign exchange analyst.

Jordan Rochester, a foreign exchange strategist at investment bank Nomura in London, says the Pound is unlikely to find much support in the near-term but an acceleration in the UK's covid-19 vaccination programme could help shift sentiment on both the UK economy and its currency.

"The vaccine rollout has been slower than hoped, but that still doesn’t change our view and hopes that this is the last winter of lockdowns. With the market’s medium to long-term view still pointing towards the 'back to normal' trade downside on GBP should be limited, especially as positioning is very neutral," says Rochester in a research note to clients out this week.

Expectations for further advances in Sterling have seen Nomura initiate a 'long trade' (i.e. they are buyers) on GBP/USD, looking to target a rise to 1.42 in 2021.

In the short-term, Rochester expects Sterling to be more responsive to the Dollar side of the Pound-to-Dollar (GBP/USD) equation as the UK currency faces some near-term uncertainty ahead of a more constructive 2021.

The prediction comes in the same week that Sterling reached a fresh multi-month high against the Dollar, but most analysts say the upside in the GBP/USD pair is largely linked to a broader depreciation in value in the Dollar.

The Pound-to-Euro exchange rate (GBP/EUR) is meanwhile expected by Rochester to remain range-bound until the COVID-19 landscape improves, a possibility as the distribution of the covid-19 vaccine accelerates.

This expectation dovetails with a technical observation that the recent decline in the value of Pound Sterling against the Euro at the start of 2021 is consistent with the exchange rate falling back into what has now become a multi-month range, defined by ~1.13 at the top and ~1.0750 at the bottom.

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For now Sterling appears stuck in a rut against the Euro, but if the expectations of Nomura are proven correct upside can be expected in coming months.

"With the shock of a no-deal Brexit ruled out UK Inflation expectations may soften further, boosting UK real yields and with it likely leading to a higher pound. If 2021 is the 'return to normal' trade then the UK is currently one of the worst affected countries in the G10 and thus may experience one of the biggest recoveries," says Rochester.

The view that those countries that were most severely impacted by the pandemic have the greatest bounce-back potential is shared by others.

According to Oxford Economics, those countries that suffered the most under the covid-19 crisis are set to see the most aggressive recoveries in 2021.

"We anticipate a sustained relaxation of restrictions in some advanced economies around March/April, triggering a mid-year mini boom," says Ben May, Director, Global Macro Research at Oxford Economics.

Oxford Economics note Spain and the UK experienced the largest economic hits from the virus in Europe, but they stand to outperform when the recovery takes shape.

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Others agree.

"Given that the UK economy has been hit hardest by the Covid-19 crisis, it stands to benefit the most from vaccines," says Paul Dales, Chief UK Economist at Capital Economics. "The economy is like a trampoline – the lower you go on the way down, the higher you go on the way up.

But Nomura's Rochester warns that the risks to a bullish stance on the UK economy and Pound Sterling include the Bank of England cutting interest rates to 0% or below in February owing to the latest lockdown as well as the potential for bad news from vaccine developments, such as the current slow roll out continuing, supply constraints or the new variant’s spread.

The pricing on financial markets for an interest rate cut at the Bank of England has risen since UK Prime Minister Boris Johnson announced a tightening of lockdown restrictions in England on Monday night, with markets betting Threadneedle Street will need to offer more support to cushion the economic impact of the measures.

The typical rule of thumb in foreign exchange markets is that when a central bank approaches an interest rate cut the currency it issues declines in value.

Hence, expectations for a rate cut in early February is on balance viewed as negative for Sterling.

But Rochester does not believe the Bank will cut rates.

"Vaccines should feature in forecasts and the current drag on growth should be viewed as temporary. Working from home and adapting to COVID-19 in the workplace is now commonplace, and so the economic impact will likely be less. So it’s not so clear in our view why the BoE needs to cut rates into negative territory when the path to recovery is still in place," says the analyst.

However, were the Bank to cut rates the Pound would likely fall says Rochester.

"UK real yields would fall, with the impact across the UK yield curve likely to drag shadow rates down with them, perhaps falling below that of the US on this measure," says the analyst. "Negative rates would be a regime change for GBP fixed income (which has long played the role of a positive-yielding proxy for European reserve currencies) and with it we’d expect several weeks of GBP underperformance, if this risk were to occur."

Nomura forecast the Pound-to-Dollar exchange rate to trade at 1.45 at the end of 2021, the Pound-to-Euro exchange rate is forecast to trade at 1.1360.