Pound’s path beyond $1.30 rests on Brexit talks, growth data and dollar strength
Sterling is worth $1.30 for the first time since September, helped over the line by stronger-than-forecast retail sales data. Its march higher began after the UK election was announced. So what is the significance of the level and will it hold? Was the breach of $1.30 expected? By some. In recent weeks, investors and forex analysts have grown more convinced it would break $1.30, underpinned by UK economic data and weakness in the dollar, which is suffering from Donald Trump’s political problems. Signs of a turnround in sterling’s fortunes have also emerged in the past four to six weeks from data on investors’ positioning, which showed bearish bets on the pound coming off.
But a broader look at the pound shows just how far away from $1.30 sterling was looking until recently. Uncertainty over Brexit at the start of the year had driven the pound to below $ 1.20, prompting analysts to predict further declines by the end of the year. At one stage, $1.05 was a common forecast. What was the catalyst for the rally? Theresa May’s decision to hold a snap election. On the last trading day before her announcement, the pound was at $1.25. Her decision caused an immediate 2.7 per cent gain. To some extent, investors noted, a bigger Conservative majority would free her to negotiate Brexit without the impediment of hardline Brexiters seeking to cause trouble. However, investors were more enthused about the change in the Brexit timetable that the election created. The fear had been that an election in 2020 — when the next one had to be called by — would put the prime minister under pressure to negotiate a hasty and unsatisfactory deal by the 2019 deadline. An election now means the next one is postponed until 2022, thereby kicking the Brexit deal down the road and opening up space for a transition deal — something investors favour. What has kept the pound buoyant? Expectations of a hawkish Bank of England. Growth and rising inflation around the world are prompting investors to focus on policymaking. But UK inflation is rising too fast for wages to keep pace and will force the BoE to rein in those expectations. Governor Mark Carney certainly was not encouraging any hawkish sentiment at the BoE’s recent meeting. Still, BNP Paribas thinks the pound is undervalued against the dollar, and says “the underlying language had hawkish elements”, so risks to BoE pricing remain to the upside. How significant is this $1.30 level? Forex hedging advisers say the level will be welcomed by UK importers: they have struggled to meet budgets since the pound’s devaluation, have been reluctant to pass on increased costs to customers and have been frantically trying to renegotiate supply terms and facing hits to profits and margins. The new level at least enables them to lock in the $1.30 rate with short-term hedges.
Analysts also expect various stop-loss positions to be triggered at the $1.30 level, which would send sterling higher. So after $1.30, what’s next? $1.40? That would be a stretch. Another 10 cent gain for the pound would indicate the market was confident of a satisfactory Brexit deal. But there are plenty of other factors capable of holding back the pound, such as a revival in the dollar and a string of poor UK data. Still, the first of these is looking unlikely, despite probable US rate hikes, while global growth would somehow have to bypass the UK for the second scenario to occur. Brexit remains unpredictable, but there are signs the market has priced this in, so bad Brexit news may not weigh too heavily on sterling.
There are analysts who think sterling will get to $1.35 by the end of the year, but there is a better case to be made around $1.32. In all probability, sterling will hover around $1.30 for a while yet.