GBP/USD Rate: Forecast Downgrades Loom, May to Press on and Govern with DUP

Pound Sterling is seen stabilising against the Dollar, Euro and other major currencies as we move through the early afternoon session in London.

The City has taken some confidence from Theresa May's determination to go ahead and govern with the support of Northern Ireland's DUP.

In an address to reporters outside Downing Street the PM made no mention of her party's poor showing overnight but rather tried to divert focus to the job at hand.

The news has allowed financial markets to settle somewhat.

1 GBP currently buys 1.2747 USD on the inter-bank market, the rate opened today at 1.2822 and had gone as low as 1.2635 earlier in the day.

More Uncertainty Certainty

No party will be able to control the UK government alone in what amounts to a disastrous night for the Conservative party and its leader Theresa May.

Brexit talks are due to start on June 19 but it appears that the UK will have to perhaps delay the start of the talks owing to the shift in the political landscape.

But a wafer-thin majority of two hardly inspires confidence and does not convey a strong mandate for negotiations.

The prospect of a so-called rainbow coalition, led by Labour and including the SNP, the Liberal Democrats and Plaid Cymru is also unlikely as the Liberal Democrats have overtly stated they would never enter such a coalition again.

In fact, if all the opposition clubbed together they would still be unable to govern.

Some analysts have suggested that such a coalition would be a best-case scenario for Pound Sterling in that it allows for a soft Brexit.

“It goes without saying that the UK political risk premium has risen markedly, but the situation is fluid. A Conservative coalition with DUP, for instance, may mean a softer Brexit, but it could also mean the Tories are less able to maintain a tight fiscal policy, leading to monetary policy normalisation earlier than previously expected,” says Sue Trinh at RBC Capital Markets.

The outlook for the Pound to Dollar exchange rate is understandably poor.

UniCredit see Pound Forecast Downgrades Ahead

The political instability being witnessed suggests the UK as an investment destination for foreign capital is now in question; a development that has major implications for Sterling.

The UK is reliant on the inflow of foreign investor capital to keep the value of Sterling elevated and its economy oiled.

When these inflows dry up Sterling must fall in order to create a discount for further inflows.

UniCredit Bank point out that during the years of the Eurozone debt crisis (2010 to 2012) the UK experienced a surge of portfolio inflows as growth was firming and the economy was perceived to be a safe haven amongst G10 countries.

"But this has changed since the Brexit vote: indeed, balance of payments data for 4Q16 show that foreign portfolio investment is going into reverse. This process should gain more traction now that domestic political risk premia rise even further," says UniCredit's UK economist Daniel Vernazza.

As a result, UniCredit say their already bearish GBP forecasts (GBP-USD at 1.28 and EUR-GBP at 0.89 by year-end) "are now subject to deeper Sterling downside risk".

Note that EUR/GBP at 0.89 equates into a Pound to Euro exchange rate at 1.1236.

UniCredit see a fairly good chance that EUR-GBP rises to 0.90 rather swiftly and potentially towards 0.95.

In Pound to Euro exchange rate terms this equates to 1.11 and 1.0526.

Pre-election rate spreads suggested that Pound Sterling was actually looking expensive against the Euro.

"With the prospects now that over the next few weeks UK yields come under increasing pressure and Gilt-Bund spreads narrow even further, more upside for EUR-GBP seems inevitable in our view," says Vernazza.

"And to the extent that over the medium term U.K. yields rise as a reflection of elevated risk premia, any potential re-widening in the spread is unlikely to offer support to Sterling. Both short-term and medium-term GBP's prospects appear daunting to us."

But ING say it's Time to Buy the Pound

A fresh report released by ING in the wake of the recent political events suggests Sterling is now oversold.

Analysts at the Dutch bank believe that the UK will now have to consider pursuing a softer brexit, and this will help Sterling.

“It may be way too early to conclude this with any certainty right now, but the loss of Conservative seats – and rise in Labour foothold – suggests that the dial within the UK parliament may tilt towards a ‘softer’ core Brexit view, with some ‘hard’ Brexit pushback,” says Patel.

ING believe buying GBP/USD would be the best way to trade this view.