GBP still very delicately poised - Natixis

Analysts at Natixis note that despite some good macroeconomic data, sterling extended its correction in the first quarter after Theresa May confirmed she was favourable to a “hard Brexit”, even though this means giving up access to the single market and waiving European passporting rights.

Key Quotes

“The Prime Minister wants to negotiate a new trade agreement. Article 50 was triggered on 29 March. The European Council is to meet on 29 April when the EU’s position will be outlined. This position will then be detailed over the following month in the form of negotiating directives. To begin with, negotiations should focus on the Brexit bill, which is put at around €60bn by the EU. Note that, at the end of the 2-year period defined by Article 50, three months will be needed for the agreement to be ratified by the European Parliament. This means therefore that the UK will have 18 months to wrap up the negotiations proper. Under these conditions, Theresa May will probably attempt to negotiate transitional agreements, which also promises to be challenging.”

“Sterling is now undervalued as measured by its real effective exchange rate. Short sterling positions held by speculative accounts stand at record levels and can be squared at any moment, possibly fuelling a technical rebound by the British currency. Furthermore, one of the members of the Bank of England’s Monetary Policy Committee voted for a hike in the bank rate given that the unemployment sits at a record low and that inflation exceeds the central bank’s official 2% target. All these factors point to sterling being stronger.”

“Even so, we remain negative on sterling. It has been shorted by the market for several months, which has not prevented the currency from extending its correction. A hike in the bank rate also looks unlikely given that the Bank of England is concerned the British economy will slow in coming quarters. Business surveys already show some signs of faltering, as does the property market. Uncertainties over economic relations between the UK and the EU will go rising, especially if there are frictions from the onset over the Brexit bill. Finally, the prospect of a second referendum on Scottish independence is another factor that is likely to stoke uncertainties at the level of the UK.”

“In other words, the market seems excessively complacent in the face of these political and economic uncertainties. We remain bearish on sterling against both the US dollar and the euro. We still expect the GBP/USD to weaken to 1.18 in coming quarters, while we expect the EUR/GBP to briefly test 0.92.”