Pound Sterling to Extend Lower Against Dollar: BK Asset Management

We are supposed to be in the dog days of summer but with the weather just beginning to warm up here in New York, investors are getting chills from the volatility in the British pound this past week.

Sterling dropped more than 2% on Thursday evening to its weakest level in 6 weeks and the worst may be yet to come.  If there's one thing that we have all learned over the past 12 months it should be that polls could be dangerously inaccurate.

We saw it with Brexit, the US election and now the UK election.

The "smart strategic move" by Theresa May turned into a nightmare for the Conservative Party and the British pound.

When David Cameron rolled the dice by calling a Brexit referendum, he saw a humiliating defeat.

Now Theresa May is in the same boat as she struggles to recover from her failed gamble to consolidate power ahead of Brexit negotiations.

Not only is she barely holding onto her job but the strong and stable government that she hoped to create is now in shambles.

May is putting on a brave face by confirming Brexit talks will begin in 10 days but the country is divided and her Brexit strategy is in tatters.

Unfortunately the EU is aware of her defeat and are likely to use it to their advantage. She'll need to be more conciliatory if she hopes to get the approval from those in parliament who preferred to stay in the EU.

So while arrogance could have her initially pursuing a hard exit, she'll have to settle for a soft one.

This is bad news for the British pound. Sterling consolidated its losses on Friday but this is strictly a relief rally on the hope for some sort of compromise solution.

The government is weakened and the economy is in flux.

Recent data hasn't been terrible but with inflation at a 3 year high and wages falling the U.K. is headed for trouble.  Foreign investment and net migration will fall in the coming months/years negatively affecting tax revenues and growth. Brexit is the trickiest divorce ever and May's plan needs to be completely rethought.

Back in 2010 when the UK last experienced a hung Parliament, there was an initial drop followed by a few days of consolidation and then a sharp slide lower.

The same price action appears to be happening now although the relief rally may be shallower given the consequences for Brexit negotiations.

This week is a busy one for the U.K. with inflation, consumer spending and retail sales scheduled for release along with a Bank of England monetary policy announcement.

However politics could overshadow economics as no changes are expected from the central bank.

Since the last monetary policy meeting, retail sales and inflation increased (though we'll get a more up to date reports before Thursday) but GDP, manufacturing and service sector activity slowed.

The softness in PMIs was also reinforced by the weaker industrial production report on Friday.

One way or the other, we expect to see 1.25 and probably even 1.24 in GBP/USD.