Back to Brexit for the Pound Sterling as Strategists See BoE Effect Fading

Grounds for another BoE rate hike are low and likely to diminish further as time elapses, leaving Sterling wholly exposed to Brexit-related shifts in sentiment. 

Sterling could weaken over the coming days as traders return their focus to renewed Brexit negotiations, according to one strategist, who predicts the positive impact from the Bank of England’s November interest rate hike will wane further in the coming weeks.

Further moves from the central bank are unlikely in the short term, says Sweden’s Skandinaviska Enskilda Banken (SEB), as when the UK’s currency-related inflation begins to recede policymakers are likely to wait for a further pickup in wage growth before tightening again.

“We still believe the BOE’s forecasts of inflation and growth are on the high side and expect inflation to fall more rapidly next year, while growth is likely to disappoint,” says Richard Falkenhall, a foreign exchange strategist at SEB.

Moreover, growth in average wages is set to remain on the low side given a moribund outlook for productivity growth, according to Falkenhall, which reinforces the likelihood of a stand-still at the BoE.

The SEB strategist also flags “several comments” in November’s monetary policy statement that suggest further interest rate moves are a long way down the road.

“Consequently the GBP is unlikely to be supported by further BOE interest rate increases this year or next and from a currency perspective monetary policy is probably off the table for now,” Falkenhall writes, in a note Thursday.

Meanwhile, uncertainty around the eventual outcome of the Brexit negotiations could soon begin to weigh on the Pound again, as the ball begins to roll on the next round of talks this Thursday (today).

“So far negotiations have been slow, and there are few signs of progress yet. This suggests a rising risk premium on the GBP going forward,” Falkenhall notes.

The Pound-to-Euro rate has compressed a more-than 7% year-to-date loss down to around -3.9% during recent weeks, while the Pound-to-Dollar rate has held onto a 6.2% gain in the face of a strengthening greenback.

Recent price action around Sterling was aided by the UK’s first interest rate rise in more than a decade and renewed weakness in the common currency, brought about by a dovish European Central Bank.

Pound Sterling Live reported Thursday how some economists and strategists are optimistic that Prime Minister Theresa May will make the neccesary concessions to EU negotiators ahead of December's European Council summit.

Markets are looking to see negotiators cleared to move onto the subjects of trade and transition after the summit given a tight timetable for an agreement to be reached. 

“We are still hopeful that there will be enough progress in the talks for EU leaders to give the green light to move on to trade negotiations in December,” says Falkenhall. “Should this fail to happen, it would most likely weaken the GBP substantially, while signs of progress would strengthen it.”

Falkenhall and the SEB team forecast a positive conclusion to the Brexit talks in 2019 and a steady appreciation for the Pound throughout 2018 however, the coming weeks represent something of a bottleneck in terms of sentiment-risks.

SEB forecasts the EUR/GBP rate to rise to 0.9200 before the end of 2017, which implies a substantial fall in the Pound-to-Euro rate over the coming weeks, back to the 1.0869 level.

However, 2018 should see it return gradually more or less to current levels, somewhere in the 0.88 area, which implies a Pound-to-Euro rate of around 1.1360.

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