GBP: Guided by political uncertainty – Rabobank

According to Jane Foley, Senior FX Strategist at Rabobank, given the backdrop of heightened political uncertainty in the UK, it is a relief that at least there is a fairly strong consensus with respect to the central bank outlook.

Key Quotes

“In line with our view, the market sees around an 80% chance of a 25 bps rate hike from the BoE on August 2 against the backdrop of a tight labour market and a consumer sector which appears to have been bolstered by a combination of warm weather, royal wedding and world cup fever.”

“Expectations that the Bank is set to raise rates is likely to afford GBP some downside protection.   That said, against the backdrop of political turmoil the pound remains vulnerable.   Given the gulf that is opening between the pro-Brexit and pro-(EU) Remain factions of PM May’s government and the fast reducing number of weeks before a Brexit plan must be in place, the pound could slip further.”

“We expect EUR/GBP to trade at 0.89 on a 3 to 6 month view.   This assumes that a UK/EU trade deal will eventually be in place and that a hard Brexit will be avoided.”

“The political events in the UK over the past ten days or so have been both fast moving and complex. For GBP investors, however, the choice of reactions is clearly limited.   The relatively confined degree of GBP volatility in recent weeks suggests that political uncertainty has chased many potential market players to the side-lines.”

“For the rest, the remaining choice is binary.   This has forced the complexities of Brexit into two simple channels.   GBP rises if the market assumes that the chances of a soft Brexit are on the rise and drops if the Brexiteers appears to be winning back ground.”

“For the BoE the uncertainties connected with Brexit clearly pose a challenge.”

“Although the MPC will not speak directly about the outlook for GBP, the risk that political uncertainty could drive GBP significantly lower and lead to another surge in CPI inflation also suggests that the MPC may favour hiking rates again this year.”

“This should afford some protection for GBP, particularly given the ECB’s very dovish guidance on rates.   That said, on a hard Brexit we would expect GBP to fall sharply.   Although it is not our central view, in these circumstances we would not rule out a move to EUR/GBP 1.00.”