Pound-Dollar Rate Still an "Undervalued" Buy at CBA  

- 'Undervalued' GBP/USD tipped as a buy at CBA this week.
- 'Fair value' seen near 1.55 amid repricing of BoE outlook.
- As vaccine success leaves economy eyeing top of board.

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• GBP/USD spot rate at time of writing: 1.3884
• Bank transfer rate (indicative guide): 1.3508-1.3605
• FX specialist providers (indicative guide): 1.3686-1.3797
• More information on FX specialist rates here 

The Pound-to-Dollar rate is this week struggling to recover back above 1.39, but Sterling remains significantly undervalued on at least one important metric according to strategists at Commonwealth Bank of Australia (CBA) who've tipped the currency as a buy in anticipation of a further rally in the year ahead.

Sterling remained the best performing major currency of 2021 while recovering ground ceded to the Dollar during last week's bonfire in the bond market, which has abated thus far in the new week and ahead of two large U.S. government bond auctions due on Wednesday and Thursday. 

The Pound-to-Dollar rate rose sharply off the week's opening level near 1.3820 to probe briefly above 1.39 but improved UK economic prospects mean it could have much further to rise later this year and thereafter. 

"We now predict GBP will gain significantly from undervalued levels. Look to buy GBP/USD at current levels (1.3865) with a tight stop loss at 1.3720," says Elias Haddad, a senior FX strategist at CBA. "Purchasing-power-parity based on relative GDP deflators is around 1.5500. Second, the UK current account deficit is the smallest since Q1 2012. This means GBP no longer needs to trade at a significant discount to its fundamental equilibrium to attract foreign savings."

Above: Pound-to-Dollar rate shown at daily intervals. 

The UK's early start vaccinating has enabled it to pull ahead of all other countries except the U.S. and Israel while in the process offering the economy a shot at reopening and recovery before others in Europe. But with HM Treasury extending its emergency programs for months more in last week's budget, the economy will also benefit from a fiscal tailwind worth a double-digit clip of GDP as it reopens in spring and summer.

As a result UK growth is now widely forecast to be among the fastest in the developed world this year and market expectations for interest rates at the Bank of England (BoE) have been rising, although CBA's Haddad says the latter still have "room to adjust higher in favour of GBP." Expectations have risen elsewhere too lately and most notably the U.S. where a sell-off in the government bond market spilled over into other debt markets before eventually also upending stocks and commodities these last few weeks. 

"The pound’s positive drivers remain unchanged: it has rolled out vaccinations quicker than most and the BoE may lay out a tapering of asset purchases at its Mar 18 meeting. Those factors should continue to lift the GBP above the rest, especially if murmurs of an earlier reopening surface," says Shaun Osborne, chief FX strategist at Scotiabank. "GBP may find itself trading in a 1 cent range between 1.39 and 1.40 if it manages to clear the level today."

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The BoE is the only one major central bank not to push back against this and while also being one of few to not complain about recent currency strength, as the brighter growth outlook has instead seen it become increasingly conscious during recent weeks of upside risks that could yet threaten to crystalise an overshoot of its 2% inflation target during the years ahead.

Rising bond yields and the stronger Pound can both have an offsetting impact on inflation pressures over a one-to-two year horizon hence why the BoE has done nothing to discourage them other than to warn that its contentedness is as always contingent on the ever-evolving outlook for inflation. 

This makes for a divergent stance between the BoE and others that is supportive of Sterling against most currencies and helps to explain why despite improvements in the greenback's own economic credentials, the Pound-to-Dollar rate could yet rise further during the weeks and months ahead. 

"Net GBP long positions surged to their highest levels since April 2018. Optimism about the impact of the UK’s rapid vaccine roll-out programme on the country’s recovery has been feeding bullish bets on the pound. Net longs were previously lifted by the more hawkish than expected take-away from the February BoE policy meeting. That said, GBP gains have shown signs of slowing in the spot market," says Jane Foley, a senior FX strategist at Rabobank. "USD has been one of the best performing G10 currencies as the market’s expectations regarding Fed interest rate policy has shifted. Since the reflation trade is centred around US fiscal policy and growth expectations the USD could prove to be more resilient then the consensus had been expecting."

Above: GBP/USD at weekly intervals with 2-year GB-U.S. yield spread (purple line) &Fibonacci retracements of 2018 fall.