The Great British Pound Recovery

• Pound to Euro exchange rate reference: 1.1564
• Euro to Pound Sterling exchange rate reference: 0.8648
• Pound to Dollar exchange rate reference: 1.2479

Expectations for Pound Sterling’s walk out of its Brexit-shaped hole continue to grow - just as the very shape of that hole is revealed.

On Wednesday, March 29 the UK Government will trigger Article 50 of the Lisbon Treaty, and so begins the process of leaving the European Union.

The event raises a great deal of apprehension amongst the average person with an interest in Sterling as many see this event as likely to trigger another bout of selling.

The nerves could however be misplaced as the one big positive Sterling has going for it at present is that each step forward in the Brexit negotiation will offer markets, businesses and consumers a little more clarity as to their future.

Whatever the nature of the deals reached with the European Union the important point to make is that what was once an unknown becomes a known.

Remember that a currency detests nothing more than uncertainty. So already, we see a potential staircase higher for the long-under pressure Pound.

“Our expectations is that the negotiations will be long and difficult, but that it is in both sides economic interest to strike an amicable agreement. Moreover, it is likely that some form of transition or implementation period is brokered in order to smooth the path as the UK draws to a close its 40- year membership,” says Dean Turner, an economist with UBS.

The Big Risk we can All Agree on

While the provision of certainty is a positive for Sterling, it is by no means the entire story from a currency perspective.

There are warnings from some quarters that markets have been too optimistic in their assessment of how badly the whole process could go.

“In our view there are significant headline risks for GBP exchange rates over coming weeks and months,” says Peter Kinsella at Commonwealth Bank of Australia. “Some analysts argue that current exchange rates discount the forthcoming negotiations but we disagree.”

Kinsella says both sides will approach the negotiations with a strident tone, and this will unnerve markets, “with malign consequences for GBP exchange rate”.

On this point Turner agrees.

“The risk that no deal is agreed is appreciably high, moreover, there is a decent likelihood that the success or failure of the talks will not be known until the very last minute,” says Turner.

Nick Kounis at ABN Amro - the Dutch financial services giant - argues further notable downside in the British Pound is possible, but only were the UK to fail to secure a deal with the European Union after two years of negotiation.

“The main risk if no deal is struck is for the service sector. Goods trade is still possible under WTO rules but with tariffs, but possibilities for the service sector are more modest,” says Kounis.

In such a scenario, a reduction in Foreign Direct Investment could hit the economy and hurt Sterling given the large current account deficit the country runs.

Without investment inflows demand for Sterling would be diminished and the Pound would have to fall further.  

A Stable Range Against the Euro, Gains seen Against the Dollar

While uncertainty should start to clear over coming weeks and months we must keep in mind that there is a lot of work to do and additional uncertainty about whether Scotland holds a second independence referendum could keep market volatility elevated.

But Turner senses that at current levels the Pound is already discounting a substantial amount of bad news around the outcome of the Brexit negotiations.

“Thus, we continue to expect the Pound to strengthen against the US Dollar over the next 12-months, and remain in a relatively stable trading range against the Euro,” says Turner.

The base case at ABN Amro that some balance between free trade, free movement and payments into the EU budget will be eventually agreed, though the outcome is obviously highly uncertain.

Still, “a lot of bad news is priced in for Sterling, and under our base scenario, we judge that much of the weakness is behind us,” says Kounis.

Analysts at British high-street banking giant Lloyds Bank are meanwhile expecting the Pound to edge higher.

The bank have been of the view that Sterling faces relatively positive prospects in 2017 for some time now and have reiterated that call in their latest International Financial Outlook report:

“In our central view, we look for Sterling to appreciate against the US Dollar and the Euro this year to 1.30 and 1.21, respectively."

But, Lloyds concede significant political events, including the evolution of the Brexit negotiations, mean that an understanding of the risks to the forecasts is extremely important.

Watch the Data

Brexit is of course note the entire story.

What we have witnessed of late is the Pound begin to take guidance from the tenor of UK economic releases once more.

There was a time when data had little impact on the currency owing to the elephantine issue that is Brexit.

This is changing and it tells us that data - and expectations concerning the Bank of England’s moves on interest rates will matter.

Just look at the positive reaction across the Sterling exchange rate complex that followed the release of stronger-than-forecast inflation on Tuesday, March 21.

“Much of the negativity is already priced in. Thus, unless economic data deteriorates significantly now, Sterling may well be on the verge of a notable comeback,” says Fawad Razaqzada, an analyst with Forex.com.

So we must watch data carefully if this recovery is to transpire.

Importantly we are interested in noting whether the UK consumer is going to spend less as data released thus far in 2017 suggests the strong run of spending that characterised 2016 is coming to a close.

Retail sales figures out on Thursday, March 22 will therefore be of importance.

The UK economy is highly reliant on consumer spending therefore should wage data stay robust and outperform inflation then the consumer might be tempted into spending the economy through Brexit.

Because if they don’t, then the Bank of England will certainly hold back on raising interest rates and the great British Pound recovery might be delayed indefinitely.