Pound-Dollar Rate's Post-Brexit Outlook Divides Opinion

- GBP/USD outlook divides analysts as trade deal hopes rise.
- "Buy the rumour, sell the fact," advocated by some traders.
- As investor eyes GBP reversion toward long-term average.Image © Adobe Images

• GBP/USD spot rate at time of writing: 1.3340
• Bank transfer rate (indicative guide): 1.2990-1.3084
• FX specialist providers (indicative guide): 1.3158-1.3238
• More information on FX specialist rates here

The Pound-to-Dollar exchange rate has advanced back toward September highs as expectations of a trade agreement with the EU solidify but the post-Brexit outlook for Sterling is still something that divides opinion in the market. 

Pound Sterling has been heartened this week after a report from The Telegraph suggested a significant 'intervention' could be made in the Brexit talks by Prime Minister Boris Johnson to facilitate a political agreement on terms of the future trade relationship ahead of December's European Council deadline. 

Johnson is expected to speak with Brussels' Ursula Von der Leyen this week in what is billed as an intervention but which could effectively be a climbdown by the PM from objections to what have so far been controversial impediments to progress. 

"GBP appreciation is likely to be tempered by the 'thin' and non-comprehensive nature of the agreement, and by the likely inclusion of numerous sunset clauses," says Stephen Gallo, European head of FX strategy at BMO Capital Markets, who's long advocated that clients "fade" the eventual rally in Sterling.

Teams are thought to have agreed more than nine tenths of the provisions and terms that would govern the future trade relationship but have otherwise continued to butt heads over Brussels' pursuit of so-called level playing field conditions as well as for a largely status quo agreement on fisheries access.

Downing Street was under at least a veneer of pressure to give ground here on Wednesday with Bank of England (BoE) Governor Andrew Bailey having broken months of silence when appearing to equate, while not quite actually equating, the anticipated long-term effects of a 'no deal' Brexit with the up front economic costs of the pandemic.  

US PRES. ELECT JOE BIDEN SAYS WE DO NOT WANT GUARDED BORDER IN IRELAND

— First Squawk (@FirstSquawk) November 24, 2020

Above: Pound-to-Dollar exchange rate shown at daily intervals with S&P 500 ( black line, left axis) and 200-day average.

The exact depth of the agreement remains uncertain and its economic impact even more so, although the market is expected to be concerned most in the first instance with the related evapouration of the 'no deal' Brexit threat. 

However, Pound Sterling exchange rates currently reflect very little risk associated with any default to a trade relationship governed by World Trade Organization terms, according to a range of analysts, so some have suggested of late that pending upside for the British currency could be rather limited. 

The Pound-to-Dollar rate traded at 1.44 on the night of the Brexit referendum, down from a high of 1.70 in December 2015, but is treading water just above the 1.33 handle this week. Still though, few analysts anticipate a return to either of those earlier levels any time soon, with or without a deal. 

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"The primary FX driver going forward will be relative growth," says Brent Donnelly, a spot FX trader at HSBC. "GBP is not exactly pricing the worst growth story in the world at the moment (!) Brexit hopes distract from economic weakness. For now. My view is that the poor economic backdrop along with the UK’s weak external position mean GBP should probably be going lower, not higher right now and the market is probably focused on the wrong story."

Donnelly said on Monday that Sterling could rally back toward December 2019 highs or further once an agreement is reached but quickly be brought back down to earth as investors the impact of an EU exit on a UK economy that is already expected by many economists to underperform counterparts next year. 

On the face of it Office for National Statistics data suggests Britain has been badly impacted by the coronavirus and efforts to contain it, leading to a larger hole in the economy than was seen anywhere and expectations of a longer as well as shallower climb out of it. 

Above: Pound-to-Dollar exchange rate shown at monthly intervals with 200-month moving-average in black. 

Johnson's Brexit agreement would potentially be adding to bearish expectations for the UK economy at a time when investors are beginning to take their cues again from the relative pace of growth between the economies on each side of exchange rates. Expectations of a lacklustre move higher followed by a capitulation lower contrast wildly however, with the outlook of some investors on the buyside of the market. 

"It will prove to be a deal that clears a very troubling dark cloud which has hung over the pound and sends it, markedly, higher as a result," says Dr Savvas Savouri, chief economist at Toscafund Asset Management, a London based multi-asset investor with around $4 bn under management. "I have no doubt sterling will sharply gap-up to at least 1.3 against the euro and 1.6 relative to the dollar – with all the related correlates."  

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Savouri, also a partner at Toscafund, has an outright bearish view on the Dollar which he expects to fall in 2021 as China and its Yuan currency emerge resurgent from the pandemic as well as unencumbered by President Donald Trump's pursuit of a 'decoupling' between the world's two largest economies. Sterling is often said to have the strongest sensitivity to movements in the Yuan of all the major currencies, despite the UK having a lesser trade relationship with China than other major economies.

This is expected to drive Sterling's reconvergence with long-term averages against major rivals, which implies substantial upside, not least of all against the greenback. The Pound-to-Dollar exchange rate remained nearly 20% below its 200-month or 16-year average of 1.58 on Tuesday while the Pound-to-Euro exchange rate was some 12.5% beneath its equivalent threshold around 1.25.   

Above: Pound-to-Euro exchange rate shown at monthly intervals with 200-month moving-average in black.