Citi: British Pound Should Recover v Euro and Dollar

• Pound to Euro exchange rate (1-6-17): 1 GBP = 1.1464, 24 hour high = 1.1553. >> See live rates
• Pound to Dollar exchange rate: 1 GBP = 1.2876, 24 hour high 1.2921. >> See live rates

How worried should we be of the Pound plunging to new depths on the outcome of the impending election?

With the Labour party’s fortunes having rapidly improved in the polls the stakes for Pound Sterling have been raised.

However, for now at least, we note the currency has not shown any major signs of panic which is quite instructive.

Two recent polls from YouGov for the Times actually shows the Conservatives to be in danger of losing their majority and this is keeping Sterling under pressure but also suggests growing potential for a recovery should the Conservatives row themselves back into the lead.

Indeed, we saw how the currency recovered after a poll from Panelbase poll on the final day of May that shows the Conservatives are maintaining a large lead.

According to the latest Electoral Calculus data the Conservative’s projected majority is now just below 100 thanks to polls showing that Labour is fast closing the gap.

The move has lead some foreign exchange analysts to confirm they are to maintain a bearish stance on the British Pound in anticipation of it relinquishing further ground as this trend in favour of Labour continues.

“Markets still appear to be priced for a larger majority than this, with bookmakers’ prices putting the majority at 109, thought his has also fallen sharply from 161 less than a month ago,” says Adam Cole, Head of G10 FX Strategy at RBC Capital Markets.

“While this implied majority is still trending lower, we retain a negative bias on GBP,” adds Cole.

However, analysts at the world's largest foreign exchange dealer, Citibank, believe the Conservatives will see their lead extend once more.

This has them more bullish on the Pound, particularly against the Dollar in the near-term.

“We expect the Conservative Party may win overwhelming election victory, which will likely support GBP,” say Citi in a briefing to clients dated May 30. "We expect the Conservative Party would win 104~190 seats in the coming election. Overwhelming victory would help anti-Euro group to fight for more advantageous treaties in the negotiation with Europe Union.”

The result, "may smooth Brexit process and underpin GBP. For the coming 0-3 months, GBP may rise to 1.33.”

However, Citi are forecasting the GBP/USD to fall back to 1.26 in the 6-12 month timeframe.

This would coincide with the duration of the early stages of Brexit negotiations with the European Union which most analysts agree will be the hardest stage of the talks.

“The likely mounting of tensions with the EU over Brexit as soon as negotiations begin leaves Sterling exposed to a retreat,” says Luca Mezzomo, Chief Economist at Intesa Sanpaolo.

Intesa Sanpaolo see the Pound struggling over the next three months unless some impressive data releases are forthcoming from the economy.

“This time horizon should bring the most unfavourable developments, both in terms of data, as inflation should keep rising and consumption should keep contracting, and in terms of Brexit, as negotiations will begin immediately after the elections on 8 June, and will be toughest in their initial phase,” says Mezzomo.

The Euro and Dollar

Meanwhile Citi see the Euro holding sway over the near-term and this should keep any comeback attempts by the Pound and Dollar curtailed.

“With improved Eurozone data and rising US political risk, EUR may gain in the short-term,” say Citi.

Over the coming three months the EUR/USD is tipped to rise to 1.13.

The Dollar is meanwhile forecast to maintain something of a consolidative tone

Citi expect another 25 bps interest rate hike in June from the US Federal Reserve with interest rate future data shows the rate hike probability has exceeds 80%.

But, “USD may not increase much since the rate hike may be within expectation,” say Citi who note that the USD has decreased in 8 of 10 years since 2007.

“USD may remain soft in a range if this pattern persists. With the consolidation of USD, investors may pay attention to buy-on-dip opportunities on other major currencies, especially the high yield currencies,” say Citi.