'Overbought' Pound Sterling Doesn't Have Itself to Thank for Recent Gains Warn Analysts

Pound Sterling is sitting pretty against the Dollar, Euro and host of other currencies, but here is the rub for Sterling: the gains are thanks to weakness elsewhere.

Ahead of the weekend, Pound Sterling is thus far the week's best-performing currency in a group of the ten biggest freely-traded global currencies

The Pound-to-Euro exchange rate is back above 1.13 at the time of writing having advanced by nearly 0.90% this week and the Pound-to-Dollar exchange rate remains close to fresh multi-month highs at 1.3910 having advanced by 1.36%. 

This takes the exchange rate well into territory last seen during the infamous night of the EU referendum.

Above: The Pound's performance over the past five trading days. (C) Pound Sterling Live

The advances against the Dollar are important as they reflect across other crosses, for instance, gains against the Canadian and Australian Dollars might have at least part of the GBP/USD advance to thank.

Indeed, much of the stubbornness in GBP/EUR also has GBP/USD to thank - after all, the Euro has been charging higher in 2018 yet Sterling manages to catch enough of a bid to stand ground.

But, there are risks in this whole dynamic as GBP/USD's gains are seen by many to be largely a function of US Dollar weakness.

"The Pound has been grabbing more of the headlines in recent days on account of some GBP specific gains. However, the move higher in GBP/USD is still largely a dollar depreciation story rather than a GBP positive story," says Derek Halpenny at MUFG in London.

Hamish Muress, currency analyst at OFX agrees and believes recent movements are driven by Dollar weakness, which is a prevailing theme in the market at the moment.

Indeed, the USD Index, which measures the value of the dollar against a basket of currencies, was at a three-year low at the start of the week.

"It is because of this that the Pound looks overvalued right now, and may not be supporting its own momentum. Whilst we should see GBP/USD break through 1.40 this year it has to be driven and buoyed by either a pick up in the UK economy and in interest rate hike, or major developments towards a favourable Brexit with Single Market access," says Muress.

For most sceptics, it is indeed the issue of Brexit that is at the heart of any scepticism towards Sterling. While Sterling has rallied of late, at the very least uncertainty over the final Brexit outcome should ultimately cap any exuberance.

"Brexit and UK political risk continue to play a large role in GBP price action. Momentum, however, appears to be shifting towards a more orderly and transparent process, where parliament plays a greater role. Material near-term GBP appreciation, however, will continue to be capped by political uncertainty," says Marvin Bath, an analyst with Barclays.

Could the Naysayers be Wrong?

Yet, it is hard to argue against expecting more gains in Sterling against the Dollar, after all this is now a maturing trend that has been in place since the start of 2017:

Above: For Sterling, the trend certainly is your friend when it comes to the GBP/USD.

And there are a host of big-name analysts out there who believe there is a fundamental underpinning to the recovery which should extend over coming months.

"The reasoning for our bullish GBP/USD forecast for end-2018 (1.4700 vs consensus 1.3500, according to Bloomberg) is that we expect this year to be the year when the pound actually corrects on an outright basis for the first time since the Brexit referendum," says MUFG's Halpenny.

MUFG do not believe they are being particularly aggressive in their forecasts, although their levels certainly are relative to the market.

"The markets remain overly pessimistic on the outlook for the Pound," says Halpenny.

Also backing the Pound longer-term are the investment team at private bank Coutts who have Sterling as one of their conviction calls for 2018.

"The Pound still looks attractive by long-term standards and remains at the low end of its 40-year valuation range. We expect it to recover further against major currencies, especially if the UK trade deficit begins to fall which should begin soon, in our view, provided Brexit negotiations are not too prolonged," say Mohammad Kamal Syed, Managing Director at Coutts.

So could it be a case of a near-term cool down as overbought conditions readjust, followed by more gains for Sterling over the medium-term?

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