The pound was last worth $1.30 on September 30th, a day when lawyers were lining up to derail Brexit in the courts, a resilient consumer as challenging economists' dire post-referendum predictions and carmaker Nissan was demanding compensation for staying in the UK.
Investors have become familiar with such Brexit unpredictability. Yet few of them could have guessed how sterling, tweeted by Nordea analyst Martin Enlund as "the most hated currency in the known universe last week", could be close to regaining such a level so swiftly.
The working assumption for the rest of 2017 had been that, at best, the pound would carry on trading in the $1.20-1.27 range that has prevailed for the past six months. Currency traders and money managers couldn’t identify a catalyst to drive it higher until Theresa May’s snap election decision on Tuesday.
Sterling’s surge from a low near $1.25 at the start of the week to the giddy heights of $1.29 has investors asking whether this marks the start of a sustained recovery, or a climb that soon peters out once the bearish bets that traders had are fully liquidated. Ultimately, the outlook for the pound rests on what kind of deal the UK secures from the EU, and that remains a source of uncertainty.
Softer Brexit
The surprise election has raised the prospect of a softer Brexit than expected, since it relieves the pressure on Mrs May’s narrow negotiation timetable and allows her more time to sell a deal to the British public.
Alan Ruskin, a foreign-exchange strategist at Deutsche Bank, is not so sure. Investors need to ask themselves whether a soft Brexit really is on the cards, he says. "Count me as a sceptic here."
But some are more convinced, and expect further strength for the currency. Since the next election is now not until 2022, three years after the deadline for negotiations, that opens the possibility of the UK and EU agreeing a transition deal.
Sterling "should be higher", according to analysts at Nomura, up to the $1.30-1.35 range. National Australia Bank thinks it is "not difficult to envisage a return to $1.34-1.35". Bank of America Merrill Lynch and Deutsche both talk about the early election as a "game-changer" for the pound. BNP Paribas sees the euro falling from its current level of 0.8350p against the pound to 80p.
With more time on the UK’s side to strike a deal over Brexit, “the tail risks for sterling have narrowed”, says Bank of America.
BNP Paribas’s base case was that a transitional arrangement would be achieved. Now that there is no election in 2020, “this probability has risen further still,” says forex strategist Sam Lynton-Brown. “This is sterling positive.”
While that may not necessarily lead to the soft Brexit outcome the market would need to restore the pound to pre-referendum levels, investors feel a degree of uncertainty has been removed. They now foresee how a transitional deal could lead to what Nomura calls a “smooth” Brexit.
More bearish sterling watchers think this a fairly narrow view. Some say the pound’s 2.7 per cent surge following Mrs May’s election announcement – one of its biggest one-day gains in nearly half a century – was mainly sparked by the need to close extreme bearish bets against sterling rather than hailing a material shift in the UK’s prospects.
Deutsche’s Corax platform, which takes a snapshot of currency positioning data on Tuesday afternoons UK time, showed sterling being “aggressively bought”.
"The market was uncomfortable by the size of sterling shorts," says Paul Lambert, currency manager at Insight Investment.
Taking short sterling positions was a popular trade, says Alberto Gallo, portfolio manager at Algebris Investments, and so "the short-term picture is positive" for sterling if that trade becomes less popular.
Longer term, though, has anything changed? Or, as Mr Gallo suggests, is all that has happened is to delay an inevitably bad outcome for the UK economy, and to slow the speed of sterling depreciation?
He worries about low UK productivity, high household debt, inequality and the inability of the Bank of England to raise rates.
“We don’t see an economic plan for the country,” says Mr Gallo. Instead, he suggests, Mrs May’s best hope is to consolidate power, apply the same economic model, weaken the pound to soften the impact of Brexit and widen the UK current account deficit.
Economic data
Watch out, too, for some nasty surprises from economic data. The economy has held up better than economists expected, says Rabobank analyst Jane Foley, and the IMF has revised upwards UK growth this year to 2 per cent.
But higher inflation is hurting consumers, house prices are stalling, and trade negotiations with the EU could become painful. Sterling, says Ms Foley, remains “a vulnerable currency and subject to continued bouts of volatility”.
It is particularly vulnerable to the euro in the short term if France elects a mainstream candidate as president next month, and in the longer term if negotiations become difficult.
“The market is a bit UK-dominated,” says Nick D’Onofrio, chief executive of UK-based hedge fund North Asset Management. “It isn’t taking into account the euro side of negotiations.”
He thinks the market is misinterpreting the snap election decision and ignoring the prospect of a hard Brexit, predicting the euro will trade 10 per cent higher at 90p in nine to 12 months’ time.
“I’m not wholly negative,” says Mr D’Onofrio, “but sterling is going to suffer.”
The pound may have lost its “most hated currency” status for now, but the market has yet to fall in love with it again. – (Copyright The Financial Times Limited 2017)
