Pound Sterling Already Too Strong Say BNY Mellon

Six years of relentless gain for the pound have left it "not particularly undervalued" - especially versus the euro, according to researchers at BNY Mellon.

As a consequence, BNY's team expect upside to be limited for the currency in 2016, and it could even broadly weaken against some counterparts.

Data out on Thursday showing a wideing of a the trade deficit to -4.14bn - a large fall from the previous -1.07bn and well below expectations of -1.8bn - further supported the view that the strong pound may be overvalued.

Safe-haven demand is set to fall, according to the BNY note: “With the euro-zone crisis abating (for the moment at least) GBP’s safe-haven status is becoming far less relevant to investors.”

The view that the pound is overvalued versus the euro is shared by Carl Hammer, FX analyst at SEB, who says in his latest note that:

“Sterling often trades as a European Dollar. However the UK is more dependent on external trade (with the EU) , than the U.S, and sterling has reached relatively strong levels versus the euro.”

He further argues that the case for an early BOE rate hike is compromised by sterling’s current buying power:

“The high exchange rate exerts down-ward pressure on headline inflation, making the case for Bank of England rate hikes rather weak still (despite strong U.K wage growth). We expect sterling to trade more like the euro that the USD in 2016, and forecast cable to reach 1.40 next year.”

BOE to hold back for fear of down-side risks

Even analysts who are more positive about the outlook for the pound, acknowledge the BOE may hold fire for fear of higher interest rates impacting adversely on homeowners, who still remain stretched by high mortgage repayments and - until very recently – constrained take-home pay:

“Concerns about the vulnerabilities associated with the household sector will likely see the BOE tread lightly, and we anticipate a very gradual shift in monetary policy, with rate hikes likely in May or November.” Writes Dawn Desjardin in a note from the Royal Bank of Canada. 

Tighter labour market not enough to change outlook

Despite unemployment at a 7-year low and earnings expected to rise by 3.0% in 2016 many analysts are unconvinced this will be enough to make the BOE raise rates.

Respnding to a recent report highlighting the improving labour market, AFEX’s Lucy Lillicrap argued lacklustre economic growth as well as global factors were partly to blame for keeping inflation stubbornly low and preventing any change in policy from the BOE:

“Manufacturing and construction PMI were below expectations (in November) and retail sales were surprisingly down 0.6% MoM. Indeed, CPI was -0.1% y/y and even though core CPI y/y (CPI excluding food and energy) was 1.10 % the recent push below $40 per barrel for WTI will reduce inflationary pressures again.”

With no-change in sight for inflation she was not persuaded the BOE would change its stance:

““All in all while the employment survey was positive news it will probably not be enough on its own to change the current thinking at the MPC on when to raise rates with the markets still not fully pricing in the first UK rate rise until early 2017.”

Stretch still bullish

Analysts’ making a bullish call for sterling in the coming months include CIBC world Markets’ Jeremy Stretch, who referring to recent buoyant GDP figures wrote:

“Having seen the NIESR GDP reading remain at 0.6% in November, this underlies ongoing concerns regarding above-trend activity proving to ultimately impact BOE thinking, rather earlier than assumed by markets.”

“With CPI base effects likely proving positive into Q1, risk dynamics aside, we continue to favour sterling. Thus we would be looking to buy GBP/USD post the Fed, whilst we would favour selling a break of 0.7235/40 in EUR/GBP.”