15 Mar 2017

Sterling Hits Second-Lowest Point Since Brexit Vote As Political Risks Spike


Sterling is hovering around its second lowest level against the U.S. dollar since last June's vote to leave the European Union (EU) on Tuesday as unfolding political developments add to concerns over the outlook for the U.K.

In a significant day for British political news, Monday saw U.K. Prime Minister (PM), Theresa May, gain parliamentary approval to trigger Article 50 and thereby initiate the two-year process by which the country will exit from the EU. Additionally, Scotland's First Minister Nicola Sturgeon announced that she expects a new referendum asking Scots to decide whether their country should break away from the U.K. to take place sometime between fall 2018 and spring 2019.

Having demonstrated relative robustness against these events as they developed on Monday, sterling weakened substantially in early European trade on Tuesday, dipping to around $1.214 shortly after 8am GMT before recovering mildly to hit $1.2124 just before 11am.

Given the relative resilience of the U.K. economy since the Brexit referendum, particularly compared to many doom-and-gloom forecasts which have proved either premature or exaggerated, politics is currently undeniably in the driving seat regarding currency movements.

The U.K. currency hit its lowest point since the Brexit vote – and indeed since the 1980s – of $1.204 last January 16, a day ahead of PM May's speech outlining a more decisive plan and timetable for the exit process, underlining the value investors are placing on gaining some clarity.

However, the political noise is simply going to escalate once Brexit is actually triggered, according to Myles Bradshaw, head of global aggregate fixed income at Amundi.

"The bottom line is risk premia and uncertainty remain high for the U.K.," Bradshaw told CNBC's Squawk Box on Tuesday.

Meanwhile, analysts at Swiss investment bank UBS, cautioned in a note on Tuesday that given how well telegraphed the triggering of Article 50 has been, it is unlikely to "cause a major stir for sterling."

"It does however increase headline risk, particularly as the opening negotiating positions of the two sides are far apart," the analysts added.

It is also essential to pay attention to events influencing the trading patterns of sterling's key counterparts, Stephen Gallo, European head of FX strategy at BMO Financial Group, told CNBC via email on Tuesday.

"FX investors are going to mainly trade the GBP on the basis of firstly, how the upcoming Eurozone elections turn out and secondly, the tone of the initial Brexit negotiations after Article-50 is formally triggered, and that is basically what has been happening since the start of this week," Gallo posited.

"Political risks are creeping in to the trading environment for Europe's largest currencies in a simultaneous fashion, and that is why the dollar index has been buoyant over the last 24 hours," he added.

Furthermore, with markets all but certain that the Federal Reserve will hike U.S. interest rates tomorrow, Gallo anticipates further pain ahead for the British pound versus its transatlantic partner.

"We expect the next big move in GBPUSD to be on the downside, and we see the pair falling to $1.17 in three to five months," Gallo estimated.

Turning to U.K. monetary policy, Amundi's Bradshaw said he didn't expect the Bank of England to enact a similar hike this week, commenting, "It's too early."

Adding to the voices expecting additional near-term pressure on sterling given the launch of Brexit negotiations was Richard Falkenhäll, senior FX strategist at SEB, in a note on Tuesday.

"Whether this will continue or not in the second quarter depends on where market focus will be. A shift to political risks elsewhere could offer some temporary relief, but this should be seen as an opportunity to sell sterling," he advised.

Yet, Falkenhäll saved some optimism for those with a longer horizon.

"From a long-term perspective, sterling is substantially undervalued against most currencies. Our own long-term fair value estimate suggests it is around 20 percent undervalued against the euro and more than 25 percent undervalued against the dollar."

(CNBC)

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