With so many now betting against the pound, the question seems to be how much will the pound fall by, rather than if the pound will fall. Whilst the pound received some welcomed support last week, many still expect pound to euro and pound to dollar to target much lower levels over the coming weeks.
Karen Jones, Head of Technical Analysis for currencies, commodities and bonds and Commerzbank thinks pound to euro will target 1.1037 shortly, and technical analyst colleague Axel Rudolph is looking for pound to euro to target 1.02 within in the coming weeks. 1.02 is as near to parity as pound to euro has ever been and this was reached during the 2008-2009 financial crisis.
A weak outlook for sterling is also supported by Wall Street Analyst Sheena Shah of Morgan Stanley, who expects the pound to see fresh lows against the euro and US dollar over the coming days and weeks. Shah commented that the pound had been at risk since COVID-19 gripped the UK in late March, however the pound is now weakening as investors look towards Brexit trade negotiations. Shah said, “Until a Brexit deal has been reached, we expect any GBP rallies to limited.”
There is one more round of trade negotiations between the UK and EU which will take place early June. This will be the last of 3 virtual negotiations before the UK decides whether to request an extension to the transition period, currently due to end on 31 January 2021. The UK has continually stated that it will not request an extension to the current period and with no progress in trade talks thus far, investors are now beginning to fear the UK-EU trading on World Trade Organisation rules next year.
Morgan Stanley are forecasting pound to euro to fall to 1.0870 and pound to dollar to fall below 1.20 with next resistance at 1.15 if no extension is agreed. However, it is worth noting that Morgan Stanley still expect the UK to request an extension and as such, only assign a 40 percent probability to the above scenario. If an extension is requested, Morgan Stanley expect the pound to rally.
UK and EU at Deadlock on Trade Talks
The EU is demanding that the UK agree to its “level playing field” and include access to UK fishing waters for its nation states within the free trade agreement, however the UK is saying the EU’s level playing field demand would not allow it to diverge away from Brussel’s rule and determine its own laws. The UK also wants access to its fishing waters to be agreed separately to any trade deal and reviewed on an annual basis, but the EU are demanding fishing is included within the trade agreement putting the camps at odds.
The lack of progress to date and refusal of either side to budge has concerned investors and with little sight of a will to compromise, the prospect of no-deal has increased. This has sent the pound lower as investors are concerned that the UK will lose access to the EU’s single market and this in turn will damage the UK economy. In addition, the lack of access to the EU market could make the UK a less attractive place to invest or overseas investors.
Further QE and Negative Rates Weighing on the Pound
Whilst Brexit will be the main driver behind pound to euro and pound to dollar rates over the next month, there are other factors also weighing on the UK currency, the Bank of England’s monetary policy being one. Comments from BoE Governor Andrew Bailey and Chief Economist Andy Haldane have raised the prospect of further quantitative easing at June’s BoE meeting and markets are also partially pricing in the possibility of the UK reducing its already historic interest rate from 0.1 percent to zero or lower.
Investors widely expected further quantitative easing but the bank’s willingness to print money and consider negative interest rates for the first time in history, following a series of disastrous economic data, paints a gloomy picture going forward.
Increased bond buying by the UK government has driven the return on GILTs (Government bonds) below 0 for the first time as the BoE buys the UK’s debt. Last Wednesday, UK government bonds auctioned for maturity in 2023 sold at -0.003 percent. This is good news for the UK government as they can borrow cheaply but the UK relies on inward investment from overseas investors, and if the investment is unattractive, less money will flow into the UK and pound will face losses.
Lastly, the “v-shaped” recovery that many economists had hoped for appears to be yesterday’s news as most now expect the UK to have a much slower recovery, perhaps taking up to 2 years before the UK returns to pre COVID-19 levels.
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