ING Downgrade British Pound Forecasts vs. Euro and US Dollar Citing Sterling's Very own Summer of Discontent

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- Political clouds over Westminster won't clear until October

- Pound headed back toward post-Brexit lows

- A more sustained recovery is however forecast for 2019

The Pound is headed back toward its post-referendum lows over the coming months, according to analysts at ING Bank N.V. who have downgraded their forecasts for the UK currency over near-term timeframes.

ING have, for the most part, struck a relatively constructive view on Sterling, and hence the downgrades carry some significance we believe. Analysts at the Dutch-based multinational are arguing that fears over the UK's departure from the European Union are increasing and that they will dent the British currency more than had been previously anticipated.

Negotiations between the UK and EU were always going to be acrimonious and fraught with risk but the process through which the UK will leave the European became all the more arduous during July, and the risks of a "no deal" Brexit more palpable.

This was after Prime Minister Theresa May set out her "Chequers plan" for Brexit earlier this month, the details of which prompted a wave of resignations from the cabinet and injected a significant dose of political uncertainty into Sterling valuations.

"GBP is cheap both on a short-term (Bank of England and UK economy) and long-term (soft or 'status quo Brexit') basis. But the political chaos in Westminster makes it a good reason to trade at a discount," says Viraj Patel, an FX strategist at ING Group's London unit.

The Pound-to-Euro exchange rate currently trades around 1.12, having been as high as 1.1470 in mid-June. The Pound-to-Dollar exchange rate is at 1.3092, having been as high as 1.3473 in mid-June.

ING says that a "benign scenario" that would see an easing "of short-term political headwinds" would actually see the Pound recover back to these June highs with the Pound-to-Dollar exchange rate forecast to recover back to 1.35 and the Pound-to-Euro exchange rate back to 1.15.

"Yet, the difficulty with this is that we don’t see the stormy political clouds over Westminster lifting any time before October," says Patel.

Parliamentary and party protests over the PM's latest Brexit proposals have raised the spectre of a deal that too few within the UK parliament will support.

Opposition parties will unlikely support any kind of proposal from May as their main interest is bringing down the government. Meanwhile, the Eurosceptic division of the Conservative party are unlikely to accept anymore concessions to Brussels, which will likely be granted in ongoing negotiations with Europe.

Therefore, a potential rejection of the Brexit deal secured in October in the House of Commons could see the UK exit the EU on March 29, 2019 and default to trading with it on World Trade Organization (WTO) terms.

Many have said this will be bad for the economy and, based upon this as well as the currency's actual behaviour following the vote to leave the EU, fear it would see the Pound forced to new record lows against the Euro and Dollar.

This sets the stage for Pound Sterling's very own summer of discontent on the foreign exchange market.

Particularly as an eventual deal must be approved by the European Council and ratified by all parliaments across the EU, which is a process that could take months, and the final scheduled-opportunity for the European Council to approve an agreement is less than three months away in October.

"The perceived odds of a ‘No Deal’ Brexit have increased – and this is likely to keep GBP under wraps in the near-term. There are signs that GBP markets are pricing in some degree of political uncertainty (reduced sensitivity to macro data surprises and relative interest rates, and a pick-up in short GBP positioning)," says Patel.

The uncertainty surrounding Brexit has been fuelling demand for GBP/USD options in recent days, with a notable increase in premiums for GBP put (downside) protection.

"FX options investors are now pricing-in greater downside risks for GBP after several cabinet members resigned over Brexit negotiations. Given political Brexit turmoil, GBP skew has moved for puts. EUR/GBP skew is rising and leading spot on the way up. This is a GBP bearish signal, in our view," says Vadim Iaralov, a quantitative strategist at Bank of America Merrill Lynch.

Nevertheless, ING still feel the actual odds of a no deal Brexit are significantly lower – "with economic logic to triumph over political ideology in the end," something that should allow the currency a sharp recovery towards 2019.

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Bank of England to Offer a Floor

One potential saving grace for Sterling could come from the Bank of England (BoE) in August.

Markets are betting the BoE will take its August meeting as an opportunity to raise its interest rate, for only the second rate rise since the financial crisis, which would provide some support to the Pound.

Changes in interest rates impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

Given that Eurozone interest rates remain at crisis-lows this would produce an uplift in the fundamental value of the Pound relative to the Euro, but Patel and the ING team say it would also only be likely to offer fleeting support to the Pound the entire time that markets are on edge over the trajectory of the Brexit negotiations.

Updated Forecasts for the Pound

"Despite the Bank of England raising rates in August, we believe the politics will continue to outweigh the economics for GBP in the short-term – especially if the Brexit strategy of the UK government remains one that is seemingly trying to fit a square peg in a round hole," says Patel.

"Only a concrete resolution between UK and EU officials over the Irish backstop dispute – which would effectively finalise the Withdrawal Agreement and significantly reduce the odds of a ‘No Deal’ Brexit – would trigger a material move higher in GBP over the coming months," adds the analyst.

ING have told clients they have downgraded their near-term forecasts for Pound Sterling and are "confined to" pencilling in a 1.27-1.28 trough for the Pound-to-Dollar exchange rate in the third quarter of 2018.

The Pound-to-Euro exchange rate is forecast to bottom towards 1.0860.

ING's "base case" continues to forecast GBP/USD moving back to 1.35 on the easing of short-term political risks in October/November, setting Cable on a path towards 1.40 where they see the exchange rate trading in 2019.

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