Sterling: The lady’s not for turning (Just Yet!)

There are multiple factors behind Sterling’s collapse in the past fortnight to decade lows and the question remains whether these factors will reverse any time soon.

At the top of the pyramid of causes for Sterling’s demise, in my view, is not the UK’s large current account deficit or Bank of England (BoE) policy but the stance on EU membership which Prime Minister Theresa May has adopted.

So while Sterling’s greater competitiveness may eventually drive FX inflows into the UK and help Sterling to recover, financial markets and investors are likely to continue to take their cue from the British government near-term.

Simply put, if Theresa May continues down of the path of “Hard Brexit”, however ill-defined, Sterling is likely to remain under pressure.

However, history shows that while EU leaders have a tendency to drag their feet over key issues, they are able and willing to eventually find some kind of compromise.

Moreover, Theresa May will be subject to the will of her own Conservative Party – which on the whole supports membership of the UK or at least a softer form of exit from the EU – and of the people.

While the BoE would prefer a more stable currency and lower yields, there is probably little than it can (or should) do near-term beyond trying to reassure markets, investors and households.

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Sticking to forecasts: Fed summer hike, Dollar hat-trick still on the cards, Modestly weaker EM currencies, UK to stay in EU and Sterling to appreciate

The Federal Reserve’s minutes of its 27th April policy meeting released last week set the tone for a possible June or July rate hike. On balance, recent US and global data are unlikely to have fundamentally changed the Federal Reserve’s view that a summer hike may be appropriate.

This is line with my long-held forecast that the Federal Reserve would likely hike once or twice this year, with the first hike in June. I recently updated my forecast to a July hike as it gives the Fed more time to assess US and global data and the result of the UK referendum on 23rd June. The risk is that the very threat of a hike derails financial markets sufficiently for the Federal Reserve to postpone its second-hike-in-a-decade to later this year.

Surprisingly, this message was seemingly absent from the wafer-thin policy statement the Federal Reserve issued on 27thApril.

I maintain my January forecast that the dollar’s nominal effective exchange rate (NEER)[1] may well end the year slightly higher, propelled by the resilience of the US economy and the Federal Reserve going against the global trend of easier (or at least easy) monetary policy.

Conversely, the recent modest weakening in emerging market currencies is likely to extend, as per my prediction in early April. Macro data are too weak to reassure markets that any economy can single-handedly steady slowing global growth but strong enough for the Federal Reserve to force markets to reprice the risk of tighter US policy.

My core scenario has been that the UK would vote to remain in the EU and, if anything, that conviction has strengthened following recent surveys. The lifting of this uncertainty would see a reasonably competitive sterling appreciate, albeit modestly given the UK’s underlying structural deficiencies.

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