Pound Forecasts Raised at Merrill Lynch

Bank of America Merrill Lynch upgrade their forecasts for the Pound against the Euro and US Dollar at the start of October as markets return focus to policy at the Bank of England.

With Theresa May's hold on British politics now apparently more secure, the debate about Sterling's near-term direction appears to now be shifting away from politics and towards the economy, and more specifically the question of future interest rate moves at the Bank of England.

"With talk of a leadership contest and a new PM subsiding, Sterling markets may refocus on  the upcoming BoE policy meeting," says Hann-Ju Ho, an economist with Lloyds Bank, speaking on the day the Pound gets a fillip from stronger-than-forecast manufacturing and industrial production data.

Indeed, this shift in focus by market participants is tipped to be good news for those hoping for better Pound exchange rates.

“Having held a more constructive out of consensus medium-term view on GBP for much of the year, we move our forecast to reflect the recent recalibration in UK rate hike expectations,” says Kamal Sharma, a London based strategist Bank of America Merrill Lynch.

Indeed, it was the Bank of England’s shift in tone towards UK interest rates in early September that sparked a rally in the value of the Pound. The Pound-to-Euro exchange rate rose from sub-1.08 to peak just above 1.15 while the Pound-to-Dollar exchange rate rose from sub-1.30 to highs just north of 1.36.

The Bank communicated that UK inflation is running too hot for their liking and the removal of some stimulus might be warranted in the near-future. The subtext - an interest rate rise is due in November in order to shore up support for the Pound and deprive the inflationary fire of fuel.

More than One Rate Rise?

Markets have bet increasingly that the Bank's Monetary Policy Committee will pull the trigger in November and hike rates for the first time in a decade, and this could be followed up by another hike.

“The market is now pricing a greater than 80% chance of the BoE hiking in November and has more than two hikes priced in by the end of 2018,” says Sebastien Cross, another strategist with BAML.

Others in the analyst community concur, we reported in September that John Wraith at UBS believes a second follow-up interest rate rise might occur in early 2018. 

“From a position where the Bank of England has not hiked rates in over 10-years, the UK rates market believes that it will hike rates in quick succession over the coming months and at a quicker pace than the Fed,” notes Sharma.

Traders have recently begun to speculate the BoE could follow through with a further 25 basis point hike as soon as February, with two or more rate increases now being priced into UK government bond markets before the end of next year.

But, “we find this difficult to reconcile with the mounting political headwinds and uncertainty which could weigh on growth as consensus projections imply,” says Sharma who ultimately sees limits to Sterling’s BoE-induced strength.

Sharma and Cross have believe the Bank of England will struggle to force through anything more than a single 25 basis point interest rate hike.

Curb Your Enthusiasm

A crucial hurdle to Sterling and the economy, as well as a potential obstacle to the Bank of England, are the ongoing Brexit negotiations which we note have reached an impasse of late.

This leads BAML to believe a November rate rise will be one-off affair.

Talks between Brussels and the UK are an event risk for both Sterling bulls as well as bears because each week that passes could yield either a breakdown or a breakthrough in horse trading.

With the UK government hoping talks can soon progress onto the subject of trade before year end, after the so called divorce bill is settled, the Pound will remain sensitive to news and rumours emanating from Brussels and Westminster.

“Markets remain content to trade positive news on Brexit but ignore the negative. We continue to question the durability of this current situation and suspect that GBP will become increasingly vulnerable if Brexit news flow turns more negative,” says Sharma.

Forecasts Raised, but Little Upside from Current Prices

Bank of America Merrill Lynch raise year-end forecasts for the Pound-to-Dollar rate to 1.3100, up from 1.2500, and see the Euro-to-Pound rate falling to 0.8800 before the curtain closes on 2017.

This latter forecast makes for a Pound-to-Euro exchange rate of 1.1360.

At the time of writing, GBP/EUR is at 1.1180 and GBP/USD is at 1.3168.

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