Pound-to-Dollar Rate @ 1.53 in 2018? It is Possible says ING's Patel

Above: Viraj Patel at ING

The British Pound could recover much of its Brexit-related losses against the Dollar in 2018 argue strategists at ING Group.

The bar to further substantial weakness in the British Pound is now incredibly high, according to one foreign exchange analyst, and so the easiest route forward for the currency over the coming months is likely to be up.

The call is made by Viraj Patel, an analyst at ING Group N.V., in the bank's 2018 outlook. It comes alongside forecasts for the world's major currencies, which suggest the Pound-to-Dollar exchange rate could potentially recover all of its post-referendum loss in 2018.

Patel describes Sterling as a "trashy currency" owing to its trading patterns since the Brexit referendum, which saw the currency swing wildly over the course of the subsequent year.

But recent progress in the Brexit negotiations has created opportunity for speculators to profit from a recovery, however fraught with difficulty that task may be.

“Trying to second-guess what Britain's future trading relationship with the EU will look like – and by extension the degree of UK economic openness that should be priced into GBP – is currently a mug's game,” says Patel, "but this doesn't make the Pound an untradeable currency.”

Forecasting the end-point the UK and the EU will arrive at when Brexit negotiations are concluded will be incredibly difficult but pockets of uncertainty and tension could create opportunity along the way. 

“GBP's ‘trashy’ nature, coupled with the Knightian uncertainty of Brexit, tends to see significant short-term mispricings. In fact, we sniff an opportunity right now for a positive GBP rerating were we to see further Brexit progress,” Patel adds.

The “Knightian uncertainty” label used by Patel describes perfectly the current trading conditions for Sterling and the greatest challenge for Pound traders.

[Economist Frank Knight made the distinction between risk - a situation where we do not know the outcome, but can form a judgement on the likelihood of that outcome occurring and uncertainty - where we do not have enough information to derive the likelihood of an outcome occurring.]

The unprecedented situation of Brexit means traders lack the information needed to judge probabilities for different outcomes from negotiations.

This is what has fanned the flames of volatility in Pound Sterling currency pairs this last year and what could provide opportunity to those who are bold enough to take a view on the likely end-state for the UK and EU relationship.

“More generally, we note that a lot of bad news is already priced in and despite a tricky year of domestic politics, GBP's resilience – and discreetly rising bias – confirms to us that there is a high bar to sell the currency,” Patel notes.

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While volatile, the Pound has risen steadily against the US Dollar over the course of 2017 and, in the second-half of the year, has begun to compress an earlier 7% loss to the Euro.

It was quoted at 1.3376 against the greenback Wednesday, down 0.27% on the session but up 8.4% for the year overall. The Pound was marked at 1.1325 against the Euro, down 0.17% on the session and down -3.5% for 2017.

“We believe the period leading up to April 2018 – exactly one year out from Brexit and the spectre of WTO trading rules – will be a make-or-break moment for the pound,” says Patel.

The UK government is keen to strike an agreement on the future UK/EU trade relationship and a transition phase where any infrastructural changes required could be implemented. But Brussels negotiators have demanded a “financial settlement” and assurances on citizens rights and the Irish border before they are willing to discuss trade.

“While much of 2017 has been marred by UK and EU politicians playing ‘hardball’ with one another, it appears as though the tide may be turning in a constructive direction,” says Patel.

More Upside to Come

Late November saw Prime Minister Theresa May agree to meet the full body of European demands for a financial settlement but questions remain over the Irish border. A possible deal was scuppered in the first week of December, although hopes of a breakthrough remain alive.

“Judging by GBP's rally in late November, a reassessment of the Brexit political games looks to already be underway. But we feel there is more upside to come – especially if a transition deal were to be signed, sealed and delivered in 1Q18,” says Patel.

A transition agreement is seen as important for the UK economy because it would give the City of London time to prepare for whatever post-Brexit regime materialises from the negotiations at a later date.

Without this certainty, fears are that some firms will begin moving a portion of their staff and operations to the continent earlier than they otherwise might have. The financial services industry is responsible for almost 2 million jobs in the UK, although only a fraction of those relate to business carried out in Europe.

“At a time when the BoE is in tightening mode, positive revisions to the UK growth outlook – and a subsequently steeper rate curve – could be a powerful pick-me-up for a weak Pound,” says Patel.

The Bank of England raised the main UK interest rate by 50 basis points, to 0.50%, in November as part of an effort to combat rising inflation. But expectations for further rises in the bank rate are so-far muted.

To the extent that certainty over the outcome of Brexit negotiations can impact the Pound, inflation and the broader economy, an early deal in 2018 could see markets begin to bet on another rate hike coming from the BoE sooner rather than later.

“With our house view that a Brexit transition deal will be agreed early next year, we look for any positive repricing of GBP risks to come through in 1Q18 and target GBP/USD moving up to 1.40,” says Patel. “Equally, EUR/GBP would fall to 0.86 with the looming spectre of Italian elections keeping the single currency under wraps early next year.”

The ING Group team forecast that the Pound will rise sharply against the US Dollar later in 2018, reflecting both progress in the Brexit negotiations and Dollar weakness, which is likely to take the Pound-to-Dollar rate to 1.5300 by year-end. This would be its highest level since before the Brexit referendum.

The Pound is also forecast to rise against the Euro, although to a lesser extent given expectations for 2018 to mark another year of recovery for the Eurozone economy. This will likely take the rate to the 1.1760 level, based upon the ING forecast for the EUR/GBP rate to fall to 0.8600 pence.

Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.