Now is the Time to buy Pound Sterling say ANZ, Eyeing a Recovery

- U.K. economic activity should rebound

- The local elections on May 3 hold some-short term political risks

- Buy weakness in GBP as brighter economic conditions will re-emerge

© David McKelvey, reproduced under CC licensing

A poor run for the British Pound took on fresh legs on Tuesday, May 1 with the release of some below-par manufacturing PMI data which suggests the slowdown suffered by the UK economy in the first three months of the year could extend into the second three months.

But, the decline in Pound Sterling could offer speculators the chance to profit on a recovery, according to strategists at ANZ Research - an arm of Australia-based multi-national ANZ - who say they would look to "buy weakness" in the Pound.

"We remain constructive on the outlook for Sterling and advise averaging into weakness," says Brian Martin, Head of Global Economics, based at ANZ's London office.

The short-term could however offer more volatility warns Martin, saying "the interest rate driven roller coaster ride in Sterling has continued and the May 3 local elections could add to political uncertainty in the short term."

The Pound has taken a knock ever since a slew of underwhelming data releases convinced markets that the sure-fire bet of a May interest rate rise at the Bank of England was in fact turning sour. Expectations for that rise have plummeted from above 80% in mid-April, to below 20% now with Bank of England governor Mark Carney massaging the move with comments made in an interview with the BBC.

U.K. GDP rose 0.1% on a quarterly basis in the first three months of 2018, the slowest pace of growth since the final quarter of 2012, with weather taking some, but not all of the blame.

"We expect activity to rebound," says Martin. "Critically, consumer facing services, which have been weak, should strengthen."

Retail sales were disrupted by bad weather in the first quarter of 2017 and ANZ Research note real disposable incomes are starting to rise as inflation subsides (2.5%) and nominal wages grow (2.8%).

Meanwhile, the labour market is at record high utilisation (participation rate 75.4%) and house prices are stabilising.

The ANZ view that UK data will improve is shared by analyst Viraj Patel at ING Bank N.V. who expects a pick-up in data to feed into a firming in expectations for interest rate rises which will have knock-on implications for the Pound.

"We do think there is a middle ground – and expect tightening sentiment to come back online with a 2Q rebound in UK data. Risk-reward for us, therefore, favours GBP upside going into the May BoE meeting," says Patel, in a briefing to clients.

As such, "we still thinks it’s too early to throw in the towel on our bullish GBP outlook," adds Patel, adding:

"There is a temptation to say that this is as good as it gets for the Pound. But taking a step back – one set of data releases do not alter a medium-term outlook, while the forces that have underpinned a more buoyant GBP in 2018 – namely a slow re-pricing of a structural Brexit risk premium and lower economic uncertainty – still to some degree remain in place."

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Brexit is no Stress, for now at Least

The other key driver of Sterling - something that has made it notable undervalued - are domestic political risks, and risks relating to Brexit.

We have noted E.U. Chief Negotiator Michel Barnier's tour of the Irish borders this week and pick up on his warnings that Brexit negotiations could fail unless a satisfactory agreement on the question of the future of the Irish border is found.

The tour highlights the red lines adopted by both the E.U. and U.K. in negotiations have left an inability to agree on a solution for the border - the U.K. won't enter a customs union, while the E.U. are of the opinion that it would be optimal that Northern Ireland maintain membership of the customs union. The U.K. and unionists don't agree suggesting this will in turn create a border within the U.K.

ANZ's Martin joins us in identifying potentially significant risks to Sterling from talks degenerating, something markets are yet to really pick up on. "In a worst case scenario, they fail and the UK and EU have to operate under WTO tariffs," says the analyst.

In terms of worst-case scenario WTO tariffs, it is noted the highest EU tariffs are on agriculture (12-35%) which accounts for 1.0% of UK GDP.

Tariffs on manufactured goods (ex-food) are much lower and generally in the 2–4% region.

"Productivity improvements could offset that," says Martin, adding "European countries want a strong free trade deal and Germany has said that it wants UK financial services.

"Whilst there will be periods of fraught negotiation, we’re of the view that an economically optimal outcome under differing political preferences will be reached," says the analyst.

And, for ING's Patel, UK political uncertainty is not elevated to an extent that they can be traded.

"For GBP downside to gain traction, we would need to see a significant spike in UK political uncertainty - but right now the signals from UK politics and Brexit are ambiguous," says the analyst.

Forecasts for the Pound: Up Against the Dollar, But Watch that Euro Strength

"Sterling remains considerably undervalued," says ANZ's Martin and there is certainly some recovery potential for GBP/USD to be had. The Pound-to-Dollar exchange rate is forecast at 1.41 by June, 1.42 by September and 1.42 by year-end.

ANZ are forecasting the Euro-to-Pound exchange rate to trade at 0.89 by June, 0.89 by September and 0.90 by year-end, which implies the Euro will in fact get the better of its cross-channel cousin.

This translates into a Pound-to-Euro exchange rate at 1.1236, and 1.11 respectively.

The Euro is seen as being another currency that should see sentiment improve over coming weeks, lead in part by improvements in the data pulse.

The euro area economy lost some momentum in Q1, but much of that was driven by temporary factors (weather, strikes).

It is noted that strength in the labour market has persisted (i.e. German jobs rose 145k in March, 32k) and monetary policy is very accommodative.

"The global growth and trade backdrop is also supportive of Euro Area growth, notwithstanding recent tensions. We expect the data to settle and for confidence in the euro area expansion to re-emerge," says Martin.

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