Sterling Forecasts 'Reluctantly' Upgraded at J.P. Morgan

The Pound could purchase more foreign exchange in 2018 than many analysts had previously anticipated. © Goodpics, Adobe Stock

Analysts at the world's largest investment bank have raised projections for the British currency in the wake of its strong start to the year, but appear to have done so reluctantly.

Currency analysts at J.P. Morgan have told clients they believe Pound Sterling will end 2018 higher against the Euro and Dollar than they had previously anticipated as Sterling proves increasingly resilient thanks to better-than-expected economic growth, a more 'hawkish' Bank of England and ongoing US Dollar weakness.

The moves to raise forecasts for Sterling by the investment bank are not unique and follow a pattern of Sterling forecast upgrades across the banking industry as analysts play catch-up with Sterling's ongoing recovery.

Indeed, fellow Wall Street giant Morgan Stanley have also announced upgrades this week, the details of which can be found here.

A lower “Brexit risk premium” is identified by J.P. Morgan as being behind the Pound's better performance, noting that risks associated with the event have eased.

Brexit nerves have subsided somewhat amidst mid-week reports that UK and EU negotiators are closely aligned on their positions concerning the Brexit transitional period which suggests a deal could be struck in late March when EU leaders next assemble.

Concerning the future trading relationship - which will be hammered out in negotiations after the transitional period has been settled - J.P. Morgan believe the UK will ultimately be forced to choose between two options offered by Brussels.

One option being a Norway-style relationship that sees the UK remain half inside the EU in all but name and the other being a Canada style trade agreement.

Ahead of the weekend we are reporting Sterling is edging higher on news the UK government appears to have finally settled on an unified approach to upcoming Brexit negotiations that seek to deal with the future trading relationship which appears to look like the Canada option (find out more on the Canada Plus Plus deal here).

This week we also heard that the EU Parliament is preparing a document that will urge EU negotiators to show more flexibility in UK negotiations; news that helped Sterling rise.

A number of commentators have also pointed out that both Norway and Canadian deals were at one time bespoke in nature, and the UK is therefore right to seek their own deal.

Whatever the case, the road toward the final destination will ultimately be chequered with risks for the Pound, not least because of divisions within the ruling Conservative Party over whether the UK should pursue a full break with the EU.

Resillient Economy

For analysts at J.P. Morgan, the economy is also proving resillient, and this should help the Pound.

“The modest acceleration in UK growth to around 2% doubtless contributed to the reversal of speculative positioning in GBP from heavily short to heavily long as it led to a firming up of UK rate expectations,” say J.P. Morgan.

This should encourage expectations for higher interest rates at the Bank of England in the future, which tends to prove supportive for the Pound.

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The Bank of England warned markets in February that it will raise interest rates faster than previously guided if the inflation outlook evolves in line with its latest projections for consumer prices.

The message was reinforced again by Bank of England policy-setters when they appeared before Parliament's Treasury Select Committee on Wednesday, February 22.

But, there is a clear limit to the support the Bank of England can provide as “we remain to be convinced that a modest increase in UK rates over and above what is now priced (we expect 50bp this year) will be a game-changer for GBP,” warn J.P. Morgan.

The BoE already raised the Bank rate by 25 basis points to 0.5% in November, its first rate rise in a decade, and markets are now betting it will hike rates again in May 2018.

Ultimately, it all comes down to inflation, which remained stubbornly at the 3% level in January while core inflation, which removes volatile energy and food prices from the equation, actually marched higher.

This is above the 2% target and the result of a combination of past depreciation of the Pound and last year’s rise in oil and gas prices. Brent crude, the European benchmark, has risen by more than 17% during the last 12 months alone.

“Growth may have improved in the UK but the country is still a clear laggard within G10 and monetary tightening is merely reducing the highly negative level of real UK rates,” warn J.P Morgan, adding:

“So whereas we revised up our GBP forecasts in conjunction with the broad revisions to the Dollar two weeks ago, we did so without much fundamental confidence or conviction."

Pound Forecasts Raised, Reluctantly

Analysts warn that the risks surrounding their latest forecasts are to the downside but they are nonetheless suggesting the Pound can hold its own against the Euro during 2018 while going on to win new ground from the US Dollar.

The Pound-to-Euro exchange rate is forecast to trade at 1.1360 against the Euro come the end of March, which is in line with J.P. Morgan’s earlier forecast, before declining steadily to 1.1235 in time for year end.

The year-end target is below the market price of 1.1335 seen on Tuesday but still represents a substantial upgrade from the bank’s earlier call for an exchange rate of 1.0869 by year end.

The Pound-to-Dollar exchange rate is seen rising from its 1.3991 Tuesday level to 1.42 by the end of March and, ultimately, up to 1.45 before year end.

Both of these forecasts represent substantial upgrades from J.P. Morgan’s earlier call for a Pound-to-Dollar rate of 1.30 at the end of March and 1.34 at year-end.

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Pound Supported by Bank of England Interest Rate Expectations

The British Pound enjoyed a steady recovery during the course of an appearance by Bank of England members before UK parliamentarians in which expectations for an imminent interest rate hike were confirmed.

Britain's interest rates will rise gradually but Brexit remains the biggest uncertainty to this expectation, Governor of the Bank of England Mark Carney told a sitting of the UK Parliament's Treasury Select Committee.

The Treasury Select Committee were questioning Carney and a number of his colleagues on the Bank of England's February Inflation Report at which the Bank struck a more confident tone as to the future direction of UK economic growth.

The February monetary policy meeting - the minutes of which were released alongside the Inflation Report - saw the Bank indicate: "Monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period than anticipated at the time of the November report."

The Pound rose in response to the developments in February and it appears there has been some further support to be had for the currency following the Bank of England's outing to Westminster.

The Pound staged a steady comeback against the Dollar and Euro through the course of the appearance, having endured weakness earlier in the day with markets taking an apparently dim view to wage and employment data released in the morning session.

Above: The Pound recovers against the Euro over the course of the Treasury Select Committee grilling of Bank of England MPC members.

The suggestion that interest rates will rise confirmed market expectations for a May interest rate rise; an outcome that has been expected since the Bank delivered its February policy decision and Inflation Report.

"Our current forecast is for 25bp interest rate hikes in May (to 0.75%) & November (to 1.00%). Carney says market odds for rate rise now in line with data," says Howard Archer at EY Item Club.

It is "clear that BoE guidance is 'Brexit-contingent'," says Viraj Patel, a foreign exchange analyst with ING Bank N.V. Patel agrees an interest rate rise is coming in May and believes this is still a "positive GBP story".

Above: Andy Haldane © UK Parliament, Pound Sterling Live

Also appearing before the committee was Andy Haldane, Chief Economist and Executive Director of Monetary Analysis & Statistics at the Bank of England, who says the big danger to jobs is a central bank which is forced to "step on the brakes" and raise interest rates in a aggressive manner in response to booming inflation. Therefore interest rates should be raised slowly but surely.

i.e. the Bank must not be afraid to raise interest rates in current conditions. Indeed, some commentators have argued that Haldane has made the case for a string of interest rate rises to be made sooner than his colleagues are suggesting.

Haldane also confirms wages are expected to rise to hit the 3% mark and a maximum of 3.5% being hit in about three years time.

"If markets are hinging their #BoE policy bets on wage growth data - the Bank's Chief Economist has just told us that we may get a 3% handle soon (partly good reasons, partly statistical reasons). Guess #GBP investors don't want to be late to the BoE hawkish re-pricing party," says Patel.