Pound Sterling Tipped to Remain Soft Despite a Higher Chance of the Bank of England (BOE) Normalising

Foreign exchange strategists at TD Securities have dropped their call for a rate cut at the Bank of England in Q4 2017 saying that improved economic data and a less dovish monetary policy outlook in the UK now mean the odds of a hike or cut are evenly balanced.

This viewpoint would typically considered positive for a currency as a path of rising interest rates tends to bid a currency higher.

Yet, despite the more neutral policy stance TD Securities are bearish Sterling versus the Dollar, which they see declining as USD resumes the upper hand.

TD Securities expect Gilt yields to recover in light of the less dovish BOE stance; they no longer expect a pronounced fall in yields in Q2 but do expect a marginal fall as Brexit risks increase due to triggering of Article 50.

Therefore, in the view of TD Securities, the Pound remains a politically-driven currency.

The maintain a preference for longer-term Gilts (10 year) traded “via a pay position on swap spreads.”

TD’s head of global strategy, Richard Kelly, notes how Overnight Index Swaps (OIS), which are used to calculate the probability of the central bank changing interest rates, are now calculating an increased probability of the BOE hiking - not cutting interest rates.

“The UK OIS Curve has steepened in recent weeks, with 20 bps of hiking now priced in over the next 12-months. Rate markets are reacting more to inflation expectations than Brexit risks as expected.

“We await better levels to fade the currency steepness in the curve. Gilt yields are returning to their pre-Brexit levels,” said Richard Kelly.

Although Kelly maintains a more neutral stance and markets are now pricing in a rate rise rather than cut, Kelly is negative about Sterling, seeing Brexit risks are overriding all other concerns.