Pound Sterling "has Led a Charmed Life" but Now Caution is Warranted say BNY Mellon

“If the UK government abides by these demands, GBP could well build-upon a recovery that was given life last month" - Neil Mellor, BNY Mellon.   

The British Pound could go higher against the G10 basket toward year-end, according to one strategist, although recent events in Westminster mean a cautious approach toward the British currency is in order for the time being.

Monday’s call comes amid a broad based rout in Pound Sterling currency pairs as traders continue to respond to weekend reports in The Times that more than 40 Conservative Party MPs are ready to sign a letter of no confidence in Prime Minister Theresa May.

“The Pound has led a charmed life: despite the pressures waged against it – economic and political – it has continued to enjoy the support of its nine-month uptrend against the USD and has long since recovered from the depths of 90 pence to the EUR,” says Neil Mellor, a senior currency strategist at BNY Mellon.

While the Pound has enjoyed strength over recent weeks, there are suggestions that further gains are unlikely to occur in the near-term.

Price action at the start of the new week marks a swift reversal of fortunes for the Pound given that it was the best-performing currency in the G10 basket last week. The Pound-to-Euro exchange rate is quoted at 1.1233, having been as high as 1.1316 at one point earlier in the day. The Pound-to-Dollar exchange rate is at 1.3085, having been as high as 1.3135 at one point.

“The GBP took heart from the absence of any new barriers to hinder the tortuous journey towards a trade deal,” Mellor observes. “If the UK government abides by these demands, GBP could well build-upon a recovery that was given life last month by reports of Ms May's willingness to stump-up £53 bn for a deal.

Sterling's outperformance was aided by Friday’s conclusion of the latest round of Brexit negotiations, which saw David Davis tell reporters he is hopeful that “sufficient progress will be made” over the coming weeks.

While hard details of any progress were notably absent from the summary given at the press conference, both Davis and Barnier spoke of having broken ground on some of the bigger subjects as well as technical matters.

"It was on Brexit-specific issues in particular that the market appeared to focus last week, and the price action on Friday was revealing," says Mellor who notes that at 12:15 GMT Sterling rose sharply as Michel Barnier wound up a press conference by talking of the importance of a Brexit divorce settlement if “sufficient progress [is to be made] in December”, and the need for clarification on this front within two weeks.

"Clearly, the GBP took heart from the absence of any new barriers to hinder the tortuous journey towards a trade deal," says Mellor. "On the basis of recent price activity, then certainly, if the UK government abides by these demands, GBP could well build-upon a recovery that was given life last month by reports of Ms May's willgness to stump-up £53 bn for a deal."

Yet, Mellor urges caution on Sterling in the near-term as, "the Pound's performance has belied some substantial economic and political risks; but the pressures only continue to grow,” Mellor says.

Above: Pound-to-Dollar rate shown at hourly intervals. Captures Monday sell-off.

Above: Pound-to-Dollar rate shown at daily intervals. Captures the 2017 uptrend. 

As Monday’s price action shows, political news-flow can be a double-edged sword for Sterling, rewarding the Pound while news-flow remains positive, and punishing it when the narrative turns negative.

Should parliament’s rebel MPs muster the 48 names required by Conservative Party rules to force a vote of confidence or no confidence in the Prime Minister, then the PM would face the greatest challenge to her leadership since taking the party reins from David Cameron.

This opens up the door to another potential general election which will inevitable place significant delays on the Brexit process and ultimately push the EU and UK towards a chaotic Brexit.

“It is understandable that the Pound has weakened overnight although the scope for further follow-through weakness is still likely limited unless there is more concrete evidence that Theresa May will soon be replaced as Prime Minister and/or if Brexit negotiations fail to make sufficient progress by the end of this year,” says Lee Hardman, a currency analyst at MUFG.

Above: Pound-to-Euro rate shown at hourly intervals. Captures the Monday sell-off.

Above: Pound-to-Euro rate at daily intervals. Captures 2017 volatility and fourth-quarter uptrend.

That said, a much larger number of rebels would be required to actually remove the Prime Minister from office. A party-wide bid to oust the PM seems a distant prospect particularly when considering that Michael Gove, a former leadership rival and ardent Brexit supporter, told the press at the weekend that he is still backing the Prime Minister.

“It is at least reassuring that the UK economy is continuing to hold up better than expected alongside strengthening global growth. The release in the week ahead of the latest CPI, labour market, and retail sales report will all be scrutinised closely to further assess the health of the UK economy,” Hardman notes.

Tuesday marks the release of October's UK inflation data. This and subsequent wage and consumer spending data will be as important as Brexit related news-flow in determining how Sterling trades toward year-end.

“On the economy, the BOE has delivered a hike as expected, but there is little confidence that the Bank will be willing - or able - to follow this up for some time,” says BNY’s Mellor. “There can be no doubting that Tuesday’s CPI report may move the market – a rate above 3% will see the Chancellor receive his first letter of explanation from Mr Carney.”

The Bank of England raised the bank rate for the first time in a decade at the beginning of November as part of an effort to contain rising inflation. Further moves in consumer prices and the relative health of the economy during the fourth quarter will help determine market expectations for further interest rate hikes once into 2018.

“Even were it not for the fact that pay awards are expected to trail inflation this coming year, the BOE's contentment with an inflation-target overshoot shows a reluctance to sacrifice growth on the altar of an inflation target that has been largely overlooked since 2009,” says Mellor.

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