FX Valuations: British Pound Most Undervalued, Australian Dollar Most Overvalued

Pound Sterling is shown to be the most undervalued major global currency at present having been unable to recover from the steep decline following the UK’s EU referendum held in June 2016.

Research that seeks to find the fair valuations of the world's major currencies confirms the British Pound remains cheap in comparison to its major competitors.

The news will reinforce the view that at some point the Pound must recover; however timing such a recovery remains incredibly hard.

The decline in the Sterling exchange rate since the EU referendum in 2016 comes despite the UK economy continuing to grow at a robust pace; in short the Pound is too cheap when contrasted to the state of the economy.

“According to our latest estimates AUD and CAD are the most expensive currencies in the G10, while GBP and NOK the cheapest,” say strategists at Westpac Bank in Sydney who have released the findings from their latest studies into where value lies in the global currency market.

The AUD Nominal Effective Exchange Rate (NEER) is more than 6% overvalued, up from 4% three months ago.

NEER is a measure of a currency based on its value against a basket of currencies; usually the currencies of countries that are its most important trading partners.

Westpac say higher commodity prices have boosted AUD’s equilibrium value over the last 12 months but yield spreads have trended against AUD over the same period, leaving estimated fair value for AUD largely unchanged over the last year.

The implications of these valuations could have implications for the outlook of the most over- and under-valued currencies.  

Surely an overvalued currency must decline and an undervalued currency must appreciate to restore equilibrium to the market?

If so, this suggests the Pound is long-overdue a bounce.

However, Westpac have disappointing news for those yearning for a stronger Pound; “GBP is more than 10% undervalued, much of that of course a function of the Brexit risk premium and unlikely to be reversed anytime soon.”

And with regards to the apparently-expensive Australian Dollar, “that said, a 6% overvaluation does not represent an upper extreme – there have been several historical episodes where AUD overvaluation peaked in the 8-10% range.”

So this valuation of currencies according to how cheap or expensive they are does not necessarily represent a near-term indicator but rather form the basis of longer-term analysis and decision-making.