Sterling plunge catches strategists on the hop

British currency falls for fourth day in a row amid 'hard' Brexit fears

11th October, 2016
The euro is now worth more than 90p sterling. Pic: Pixabay

Currency strategists have been scrambling to revise their long-term forecasts for sterling after the British currency fell for a fourth consecutive day.

ING, JPMorgan Chase and Julius Baer have all reduced their year-end forecasts for the pound since Friday, when it plunged 6.1 per cent against the dollar in two minutes during Asian trading. While that move was blamed on possible human error and algorithms at a time when liquidity was scarce, it was enough to prompt strategists to reassess their longer-term view.

Sterling has been unable to recover from last week’s decline as British politicians, led by Prime Minister Theresa May, failed to offer any clarity on how the government proposes to steer the country through tough negotiations on exiting the European Union.

“You have a pretty meaningful risk event” that makes it “much harder to forecast sterling,” said Petr Krpata, a London-based foreign-exchange strategist at ING. Even though from a fundamental perspective the currency is “ultra cheap,” political uncertainty could cause it to fall even further, he said.

Sterling fell 0.5 per cent to $1.2296 as this morning, having plunged to $1.1841 - its lowest since 1985 - on Friday. ING forecasts sterling will drop to $1.22 by year-end, compared with a previous estimate of $1.25. Sterling also weakened 0.3 per cent against the euro, with the European single currency standing at just over 90.3 pence in mid-morning trading.

Sterling is at the bottom of the leaderboard among its 16 major peers this year, tumbling 17 per cent against the dollar.

The Times reported that if Britain left the single market in a 'hard' Brexit, it could cost the British Treasury £66 billion a year, with economic output shrinking by some 7.5 per cent after 15 years, if Britain quits the EU without any successor arrangement.

Some observers see the weaker currency as a positive, with Brexit Secretary David Davis telling MPs on Monday that the pound’s depreciation would benefit British exporters. The pound’s decline was a “welcome change,” former Bank of England Governor Mervyn King said in an interview with Sky News.

The growing prospect of a so-called hard Brexit, where Britain would likely give up its membership of Europe’s single market to secure greater control of immigration and law-making, was the reason behind JPMorgan’s sterling revisions. That’s a U-turn from when analysts upgraded their forecasts in September on better-than-expected economic data.

“That revision was ill-timed as sterling has since slumped to a new post-referendum low,” foreign-exchange strategists at the bank, including London-based Paul Meggyesi, wrote in a note to clients dated October 7. “This decline has occurred despite a still very positive data flow and reflects instead the strong indications that PM May’s government intends to pursue a harder Brexit which prioritises lower migration at the likely expense of single market access.”

The bank now forecasts sterling will drop to $1.21 by year-end, from $1.32 previously, and will depreciate to 95p per euro, from a previous call of 87p. Julius Baer published a set of pound forecasts as recently as last Tuesday only to see them swiftly undercut by Friday’s slump. “We didn’t foresee the flash crash last Friday,” said Janwillem Acket, chief economist at Julius Baer in Zurich. “Nobody did.” The bank revised down its year-end predictions to $1.24 from $1.29.

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