Pound Sterling Will "Gap-up Impressively" vs. Euro and Dollar says Savouri

"Sterling is poised to do what it did from late 1996. Specifically, after four years of weakness following its shock ERM exit in September 1992, the pound gapped-up impressively."

Above: File image of Savvas Savouri, image source: still, (C) YouTube, Hardman & Co.

The Pound is on course to record significant gains over coming months and years says a noted hedge fund analyst, citing a supportive economic backdrop, the prospect of higher interest rates at the Bank of England and increased demand for the currency from China.

A call for big gains by the British Pound is a rare thing amongst the analyst community since the Brexit vote of 2016 and Savvas Savouri, Chief Economist at Toscafund Asset Management, says analysts at the major banks remain enslaved to negative confirmation biases regarding the UK currency.

Regular readers of Pound Sterling Live will note we value Savouri's research for its counter-consensus and original thinking, and his latest instalment confirms he remains a 'Sterling bull'.

(See here his thinking as to why the Adzuna jobs report should be the most important signal at the disposal of Bank of England policy makers).

In new research released mid-November the analyst says the Pound could be about to "gap" higher, trader parlance for a strong, near-vertical market move.

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"Sterling is poised to gap-up impressively for several reasons, including the strong UK economic backdrop, a sensible and sustained rise in the bank rate, and a potentially larger weighting in the currency basket of the People’s Bank of China," says Savouri.

The call comes as the Pound extends recent gains against a host of currencies on the back of two solid economic reports out of the UK on November 16 (jobs) and November 17 (inflation).

While in the near-term the Pound is recovering it remains lodged towards the bottom of long-term ranges against the Euro and Dollar, which Savouri suggests is in part because of persistent negativity amongst analysts and investors.

"For even when fundamentals suggest one thing, if there is a large enough body of ‘deniers’, fundamentals cannot fail to be subverted," he explains.

He takes aim at some of his peers for an apparent inability to shake their negativity towards the Pound.

"We should all try to not be bound by 'sell-side' narratives, these all too often prejudiced, inconsistent and prone to sudden corrections in recommendations - under the euphemism of 'revisions'" he says.

A sell-side analyst is one who works for the likes of the big banks, market makers and broker-dealers whose clients are other major market participants.

Buy-side analysts work for asset managers, hedge funds and are client-facing in nature.

"Availability bias and a number of confirmation biases across the ‘sell-side’ are serving to exaggerate sterling’s weakness," says Savouri.

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Savouri is a buy-side analyst; a job role best described by Investopedia as follows:

"In contrast to the sell-side analyst position, the job of a buy-side analyst is much more about being right; benefiting the fund with high-alpha ideas is crucial."

In 2021 those sell-side analysts who avoided the 'group think' bias regarding Sterling have done well, for example NatWest Markets' G10 FX strategist Paul Robson made buying Sterling against the Euro a key trade for the year.

In October Shahab Jalinoos, Global Head of FX Strategy at Credit Suisse, explicitly described an apparent confirmation bias towards the Pound displayed by his industry peers.

"Talk of stagflation is rife in the UK media, and GBP perma-bears, an ever-present market feature since the 2016 Brexit vote, have reemerged with confidence after spending most of 2021 until now in a subdued state," said Jalinoos.

Savouri says the Pound and the UK-facing FTSE 250 index continue to suffer low valuations and are still cheap in his view, "not despite Brexit but because of it".

Indeed, the Pound is about to enter a significant period of appreciation as fundamentals eventually win out:

"Sterling is poised to do what it did from late 1996. Specifically, after four years of weakness following its shock ERM exit in September 1992, the pound gapped-up impressively."

Secure a retail exchange rate that is between 3-5% stronger than offered by leading banks, learn more.

"With the Brexit referendum now more than five years behind us, I believe the UK economic backdrop from 2022 will be very much – if not more – favourable, than it was from 1997," says Savouri.

China will be a big part of the Pound's story as Savouri believes another rerating of the currency basket held by the People's Bank of China (PBoC) is due soon.

The PBoC manages the value of the yuan via a management via this currency basket - known as CFETS - primarily with a view to keep the Yuan cheap and its exports cheap.

The share of the U.S. Dollar in the basket has been steadily falling since 2016 when it accounted for 26.40% of currencies held, to 21.59% in 2020.

The Pound by contrast only accounted for 3.86% in 2016 and this was reduced to 2.75% in 2020.

But Savouri says he expects Sterling and the dollars of Canada, Australia, New Zealand and Singapore to gain added exposure in the basket soon, "all to the benefit of their capital accounts."

"If I am correct then the pound will have yet another reason to strengthen through 2022 and beyond," says Savouri.

On the matter of the all-important policy settings at the Bank of England, Savouri sees a steady rise in interest rates over coming years, that could take rates to beyond 1.6% by 2025.

He describes raising rates as "an economically sensible policy", a call which comes just weeks ahead of a potential December 2021 rate hike.

"Even ahead of these events unfolding, be in no doubt that a growing number of investors around the world will anticipate them by buying into the pound and widely across the FTSE250," he says.