Pound Drop Seen Short-Lived as Negativity Overdone, Analysts Say

According to Bloomberg, sterling pared some of its losses after falling to a one-week low on Wednesday as the U.K. officially starts the process by which it will leave the European Union. Sterling fell to $1.2377, its lowest since March 21, earlier Wednesday but has since pared losses and was at 1.2440 as of 12:05 p.m. in London.

Below is a roundup of analysts’ views before the Brexit process starts:

MUFG

• Derek Halpenny, European head of global markets research
  • Do not expect much in the way of a sharp sustained pound selloff or any notable pickup in volatility
  • Given GBP positioning, the bias would be toward a stronger pound over the coming weeks as once today’s event has passed, there won’t be much for speculators to trade off for perhaps up to six weeks
  • The first litmus test that the financial markets will be looking closely at will be the current disagreement in regard to how negotiations proceed
  • In the meantime, there might not be a lot for the markets to determine any sense of how negotiations will proceed and hence the pound might be somewhat direction-less

Rabobank International

• Jane Foley, senior currency strategist
  • Without doubt there is a lot of bad news priced into GBP. This suggests a fast compromise on the Brexit bill has the capacity to trigger some short covering
  • While it is too early to anticipate any detail from the EU regarding their negotiating stance on Brexit, the messages from both Tusk and Merkel could give a crucial clue as to the tone that will be taken
  • We see GBP as more vulnerable versus EUR in part because we see scope for further short-covering in the euro following the spring elections in France, assuming that Le Pen fails in her bid for the Presidency
  • We expect EUR/GBP to push toward the 0.89 level by the end of the year

Oxford Economics

• Martin Beck, analyst
  • We think the pound is significantly undervalued. It hasn’t broken below the October lows despite the hawkish policy shift by the Fed, a less dovish ECB and Brexit-specific shocks materializing
  • Sterling will likely rebound to 1.32 against the dollar by end-2017. We see risks of an overshoot to our forecast in the intervening period
  • The working assumption is that tough negotiations will inevitably drive sterling lower. However, there is more than a reasonable chance that pragmatism will prevail and cliff edges will be avoided given the potential costs to both sides if no agreement is reached

UBS Wealth Management

• Caroline Simmons, strategist
  • Sterling appears to be one of the cheapest currencies relative to fair value among G-10 peers and could reach $1.36 in the next 12 months
  • Pessimism in the pound looks “overdone” and it could recover from current levels if negotiations between Britain and EU are broadly constructive
  • If talks aren’t smooth, sterling could suffer some weakness but a fall to around $1.18 would likely be an attractive long-term entry point
  • UBS Wealth Management is sticking to its earlier message from January to clients to “keep calm and stay invested” in the U.K. for now

ING Groep NV

• Viraj Patel, FX strategist
  • The more market-relevant event to focus on will be the EU’s initial response to the letter handed in by the U.K. 
    • Donald Tusk is set to make a short responsive statement today, with a draft copy of the EU’s negotiating guidelines released tomorrow. This may prove to be the clearest steer yet on whether we’re on course for a soft or hard Brexit
  • The recent hawkish BOE re-pricing, cleaner GBP positioning means downside risks have increased going into today’s events, it won’t take much bad news for GBP to jolt lower
  • ING predicts GBP/USD to fall toward 1.20

Bank of America Merrill Lynch

• Kamal Sharma, strategist
  • We retain a structurally long bias in GBP/USD volatility and also believe that longer-dated GBP implied volatility is underpricing the risks of a messy conclusion to negotiations and the potential risk of a Scottish Referendum
  • Tactically bearish GBP but wary of strong April seasonals; EUR/GBP head-and-shoulders top formation on charts is a risk
  • Article 50 triggering doesn’t itself provide a catalyst for renewed GBP weakness
  • Market complacency on the ability of the U.K. and EU to strike a comprehensive deal within the timeline with the least political/economic disruption is the motivation for a move back toward the bottom end and test of the trading range

UniCredit SpA

• We fear that the picture for sterling remains exposed to some volatility: 
  • Higher inflation in the U.K. could create a policy dilemma for the BOE, given expectations that the British economy will likely deteriorate further on the back of Brexit
• Admittedly, we cannot rule out temporary spikes in GBP/USD in the near term, given the weaker USD and because data from the International Monetary Market (IMM) suggests that short positioning on GBP/USD is currently already extreme, which exposes the pair to abrupt corrections
• However, over the next two quarters, we still see a slightly weaker sterling with respect to current levels against both the USD and the euro and we therefore stick to our GBP/USD targets of 1.21 and 1.23 for end-2Q17 and end-3Q17, respectively, and a steady 0.89 for EUR/GBP over this period