With the UK set to start talks on leaving the EU, and with the country’s ability to attract funding to cover its current-account deficit uncertain, downward pressure on sterling is likely to continue. Sterling declined by roughly 6% against the US dollar within a few minutes on currency markets on 7 October. Whatever the reasons for the sudden plunge, and although there was a rapid (but partial) recovery in sterling’s value, it is quite worrying to see a major currency moving so much without any key trigger. Consequently, investors attracted by sterling’s valuation (it is 28% undervalued versus the USD using CPI-based purchasing power parity) may think twice.Indeed, the sudden plunge in sterling served simply to magnify the growing political uncertainties that have weighed on the UK currency in recent days. Of note was the announcement on 2 October by Prime Minister Theresa May that the UK intends starting formal negotiations to exit the EU “no later than the end of March”. PM May suggested that immigration control will be the government’s top priority, potentially weakening the UK’s negotiating position on all other issues, including the contours of any free-trade agreement with the EU. In addition, recent utterances by PM May and other government officials have left markets confused about the scale and composition of any change in the fiscal stance.
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Luc Luyet considers the following as important: brain, Macroview, UK fiscal policy, UK monetary policy, UK sterling
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With the UK set to start talks on leaving the EU, and with the country’s ability to attract funding to cover its current-account deficit uncertain, downward pressure on sterling is likely to continue.
Sterling declined by roughly 6% against the US dollar within a few minutes on currency markets on 7 October. Whatever the reasons for the sudden plunge, and although there was a rapid (but partial) recovery in sterling’s value, it is quite worrying to see a major currency moving so much without any key trigger. Consequently, investors attracted by sterling’s valuation (it is 28% undervalued versus the USD using CPI-based purchasing power parity) may think twice.
Indeed, the sudden plunge in sterling served simply to magnify the growing political uncertainties that have weighed on the UK currency in recent days. Of note was the announcement on 2 October by Prime Minister Theresa May that the UK intends starting formal negotiations to exit the EU “no later than the end of March”. PM May suggested that immigration control will be the government’s top priority, potentially weakening the UK’s negotiating position on all other issues, including the contours of any free-trade agreement with the EU. In addition, recent utterances by PM May and other government officials have left markets confused about the scale and composition of any change in the fiscal stance. In particular, it was not clear what the PM meant in her speech at the Conservative Party conference this week when she said that monetary policy created bad side-effects and that “something had to change”.
The political factor has thus begun to weigh heavily again on sterling, even as the economy has held up much better than many had expected after the 23 June referendum. Yet it has been noticeable that resilient economic indicators, (which might be thought to reduce expectations for monetary policy easing) have not helped push the GBP higher.
Given that UK’s ‘hard Brexiters’ are at the helm of negotiations with the EU and given PM May’s recent statements, it seems reasonable that the GBP’s exchange rate should reflect the greater likelihood of a hard Brexit. In addition, the UK’s large current-account deficit should continue to weigh on sterling as the high uncertainties facing the UK economy make it harder to attract inflows. There are therefore increasing odds that sterling weakness will prevail in the coming months, with the exchange rate moving towards USD1.20 per GBP, according to our analysis.