Pound-Dollar Rate Slides into the Weekend as New Forecasts Point Even Lower 

- GBP/USD slides into weekend as risk appetite fades, event risks loom.
- Underperforms broadly after GDP fall, Gov's refusal to extent transition.
- Brexit talks enter pivotal stage as BoE set to update on monetary policy.
- MUFG, Nomura tip lower GBP but warn on volatility and risk of reversal.

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The Pound was sliding lower against a resurgent Dollar ahead of the weekend although new analyst forecasts and commentary suggest the British currency has further to fall in the weeks ahead. 

Sterling had been riding high with the Euro and commodity currencies ahead of the weekend but crumbled in noon trade, leading the Pound-to-Dollar rate from a 0.38% increase to -0.46% intraday fall.

The Pound was left in the red against all except the safe-haven Swiss Franc, which was firmly out of favour with the whole market. Price action came amid profit-taking in stock markets and after the UK government and EU formally agreed the Brexit transition period will not be extended past year-end. 

Investors knew the government's position was not to extend the transition and were also conscious of the possibility that Friday's April GDP figures for April would be worse than the market anticipated so the turn lower might be better explained by the noon performance of stock markets.

Above: Pound-to-Dollar rate shown at 15-minute intervals with S&P 500 futures (orange line) and 10-year U.S. bond yield.

"There were building concerns that recent gains for risk assets and currencies had already gone too far, too fast recently resulting in uncomfortably high valuations amidst the unprecedented hit to global economy from COVID-19," says Lee Hardman, a currency analyst at MUFG. "We are expecting a more volatile pound in the week ahead. There is a lot of event risk including key Brexit meetings and the latest BoE policy update."

Sterling and some other major currencies have been following the S&P 500 for more than two months, although the typically riskier commodity currencies did not suffer to the same extent as the equity market or Pound Sterling on Friday and were still up against the Dollar at the close.

This pattern of price action is similar to that seen in May when the Pound fell sharply against all major rival. It also comes ahead of an important week for the currency and economy, one that combines Brexit with an important Bank of England (BoE) decision in what might be a recipe for volatility. 

"GBP has been lagging other recovery trades driven by the BoE’s decision to review policy options including negative rates, and the lack of progress in Brexit trade talks. These two factors have held the GBP back," Hardman says. "A GBP100 billion asset purchase expansion was discussed at their last meeting in May. It remains the most likely outcome with risks skewed in favour of a larger expansion. The GBP reaction is likely to depend more though on any update on the BoE’s latest thinking on negative rates. The GBP could stage a relief rally if the updated BoE communication does not reinforce negative rate speculation, and vice versa. In these circumstances, we expect a more volatile GBP."

Above: Pound-to-Dollar rate shown at daily intervals with S&P 500 futures (orange line) and 10-year U.S. bond yield.

Hardman and the MUFG team forecast a Pound-to-Dollar rate of 1.2360 by the end of June, which dovetails with new projections from Nomura that were upgraded this week. The rub for Sterling is that even the newly upgraded forecasts still imply further losses for the Pound-to-Dollar rate this month.  

"What has been impressive is the speed, size and consistency of the BoE’s approach to the COVID-19 crisis. While QE purchases have not reached a pace of 2.5% of GDP a week like the Fed, the BoE was still sizeably increasing its balance sheet at the worst stage of the market crisis in March. While several parts of the balance sheet have stopped increasing, the most important part, the Asset Purchase Programme, has kept the pace of its purchases at £14bn per week," says Jordan Rochester, a strategist at Nomura. "Instead of focusing on a specific measure we take an average and find that GBP if anything could be slightly overvalued thanks to its expanding deficits."

Nomura tips a fall to 1.23 in June, while both firms see scope for a rebound to 1.25 in subsequent months before a move back to 1.27 in time for year-end. They're also conscious of what Sterling's underperformance might mean for the outlook in the event that either Prime Minister Boris Johnson or BoE Governor Andrew Bailey turns the tide of sentiment toward the currency, which was 2020's second worst performer Friday, behind only the oil-linked Norwegian Krone.  

Above: Nomura graph shows divergence UK inflation & inflation expectations, with current EUR, USD and GBP real yields.

Johnson will e-meet EU chief executive Ursula Von der Leyen on Monday, ahead of Thursday's European Council summit which is the most obvious opportunity for progress or a compromise to be struck and capitalised upon ahead of the year-end expiry of the transition period. Investors are already betting against Sterling and the market is well accustomed to the idea of deadlock in the trade talks so even a few words of optimistic ambition might seem like a game-changer to some at this stage.

"Net positioning in CFTC futures is now short GBP, despite GBP/USD moving higher. It’s worth noting that the current level of net shorts is not extended though and is in line with the average held position over the past few years," Rochester says. "Optimism in GBP/USD calls is very limited...As a result, GBP is at risk of being a positive catalyst leading to a short position reduction. But if a positive catalyst fails to materialise medium-term GBP factors will outweigh and weakness is likely to continue in our view."

Von der Leyen would need the unanimous support of EU leaders in order to agree a compromise because a meaningful one would amount to a variation of the mandate given by national leaders, to the EU's negotiator. So while the outcome of Monday's video conference might help set the mood toward the Pound early in the new week, the announcement that matters would be unlikely to come before Thursday. The BoE decision is due on Thursday at 12:00.