British Pound Tipped to Stay on Defensive vs. Euro and US Dollar this Week, but Recovery seen in 2018 say CBA
Expect Pound Sterling to assume a defensive position over the coming week but the prospects of a continued recovery in 2018 should not be discounted argue analysts at a leading global financial services firm.
- The Pound is likely to muddle through this week but could rally more concertedly in 2018 show forecasts
- Euro not in a position to mount a substantial recovery
- Tax reform in US should be Dollar-supportive but keep eyes on Republican opposition
The currency research desk at Commonwealth Bank of Australia suggest it will be unlikely Sterling finds material upside in the short-term amidst nerves as to the outcome of the next round of Brexit negotiations.
The fifth round of Brexit negotiations get underway on Thursday, November 9 with a press conference on Friday due to deliver an update - traders will want to see some material progress before they are willing to bid the currency higher.
“GBP/USD will continue to trade on the defensive this week. The next round of Brexit negotiations resumes Thursday and we anticipate headline risks will stay elevated for GBP. There are also few GBP‑relevant UK economic data releases this week,” says Elias Haddad, Senior Currency Strategist at Commonwealth Bank of Australia.
Meanwhile, the Euro’s soft tone is unlikely to disappear as the hangover from the October European Central Bank meeting persists while we will be watching to see whether the Dollar can extend recent gains thanks to progress - albeit slow progress - on US tax reforms.
With regards to Sterling’s outlook against the Euro, Haddad reckons the Pound can advance from here as “the early start to the Bank of England's tightening cycle will guide EUR/GBP lower.”
November saw the Bank of England raise interest rates for the first time in ten years; the move was widely expected but there was a notably negative reaction by Sterling which appears to have suffered a “buy the rumour, sell the fact” action by global currency traders.
Sterling did recover into the weekend, and as our latest technical studies note, the broader trend remains positive for Sterling, provided this weeks Brexit negotiations yields some solid indications of progress being made towards the securing of an interim transitional period between the EU and UK in March 2019.
Indeed, Haddad says Pound Sterling strength will be limited by: (i) Brexit-related uncertainties weighing on GBP, (ii) real interest rate differentials, and (iii) current account balance differentials.
On points (i) and (ii):
(i) The interest rate differential being referred to is the yield on UK sovereign debt, higher yielding jurisdictions tend to attract foreign capital inflows. The Bank of England will have to hike rates more aggressively than is currently expected to achieve this. So while rates are starting to rise, we will need to see more.
(ii) The UK current account is still substantial. i.e. the UK imports far more than it exports ensuring the Pound should be weaker on basic supply and demand dynamics. The country does however manage to attract inward investment which balances out the dynamics of the poor import-export dynamic but there are fears this inward investment remains weak or could dry up if sentiment deteriorates owing to Brexit.
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The Euro’s ECB Hangover
The Euro is meanwhile seen as vulnerable “because of the ECB’s more cautious monetary policy outlook,” says Haddad, referencing the October European Central Bank policy meeting where policy-makers announced the bank will reduce its Asset Purchase programme from €60BN a month to €30bn per month from January until September 2018.
The announcement was expected, but the Euro fell on the tone of the event - the ECB is in no rush to end quantitative easing (asset purchases) nor are they likely to raise interest rates anytime soon - indeed, ECB President Mario Draghi reaffirmed forward guidance on interest rates, which places the first interest rate increase “well past” the end of net asset purchases.
So while the Bank of England has started raising interest rates the ECB is still a long way off from raising rates - this is why Haddad reckons, “the early start to the Bank of England's tightening cycle will guide EUR/GBP lower.”
US Dollar and Tax
USD consolidation is tipped by CBA to be this week’s main currency theme as the technicalities behind Trump’s tax agenda are worked out.
The Dollar has caught something of a bid over recent weeks amidst signs of progress on tax cuts with a first draft of a bill detailing the administration's desired tax reforms being released on November 3.
The Committee on Ways and Means in the U.S. Congress will begin on Monday to mark-up the Tax Cuts and Jobs Act unveiled last week.
A mark-up session is where the Committee on Ways and Means goes through the bill line by line and amends the package before advancing it to the full House for a vote (likely to be by end November).
The bill was scored by the Joint Committee on Taxation as increasing the deficit by 1.5trn over 10 years, in line with budget guidelines passed by Congress recently.
“While this pro-growth tax package is USD supportive, it is still unclear if the package will have enough Republican support to pass through Congress (House and Senate) by year-end or Q1 2018,” says Haddad.
The analyst notes Republican Senator James Lankford warned on Sunday he would not be comfortable supporting a tax bill which raises US government debt which suggests opposition to the proposals remain real.
As such, the Dollar is likely to see upside limited amidst signs of persistent opposition which will ultimately see the the scope of Trump’s proposals watered down. “The bill, or some variant of it, could pass the House in late November, but we believe it faces a high hurdle in the Senate,” says Michael Gapen at Barclays.
Forecasts for the Pound
So while the near-term picture presents something of a sideways muddle for Sterling against both the Euro and US Dollar, the longer-term picture remains constructive in CBA’s view.
CBA forecast the Pound-to-Euro exchange rate at 1.1360 by end-2015, 1.15 by March 2018 ahead of further recovery to 1.16 by mid-2018 and 1.19 by end-2018.
The Pound-to-Dollar exchange rate is forecast at 1.3860 by end-2017, 1.4140 by March 2018, 1.4550 by mid-2018 and 1.5240 by end-2018.
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