Political Turbulence To Keep Pound Down (2 min read)

The pound has had a torrid time over the past three months. It’s been the worst performing currency among G10 and the major EM currencies, GBP/USD is at its lowest level since early 2017, and EUR/GBP has breached 0.90. Meanwhile, investors are heavily short the currency. So, is it time to fade or follow the weakness?

My take would be to remain bearish on the currency for three reasons:

1. On some measures, the pound has yet to reach an undervaluation extreme (first chart). For that to happen to GBP/USD and EUR/GBP would need to be trading closer to 1.18 and 0.94 respectively. Therefore, the recent levels reached are by themselves not a reason to buy the pound. Moreover, while investors are short the pound, many segments of the market – notably currency analysts – are still biased towards pound strength, so there is little evidence of overwhelming bearish sentiment.

2. Core inflation has been steadily declining from its 2.7% highs in late-2017/early-2018 and is currently at 1.8%, which is below the Bank of England’s 2% inflation target. On top of this, the broader momentum in UK growth data has been weak – whether based on employment, manufacturing, or consumer data (second chart). Together, this should prevent the BoE from acting on its recent hawkish bias. If anything, it may need to reverse course.

3.There is an incredibly high number of upcoming leadership changes at key institutions in both the UK and EU. This will only make the Brexit path for the UK more difficult. We will soon have a new Prime Minister – most likely Boris Johnson, who leans more towards a hard Brexit. There is also growing speculation of a general election. This instability introduces downside risks to the economy. With Mark Carney stepping down in January 2019, the Bank of England is looking for a new Governor, and this could end up being one of the most political appointments in recent BoE history given the rise of populism. On the Continent, a new EU commissioner will replace Jean-Claude Junker in early November. And at the same time, a new President of the ECB will start replacing Mario Draghi. Negotiating and executing any Brexit plan by the current exit date of October 31 amid all these changes will be incredibly difficult.

Together, all of these factors will strain the UK economy and keep pressure on the currency. Now is no time to be clever and try to bottom-pick the pound.

Chart 1: GBP Not At Undervaluation Extremes

Pound valuation July

Chart 2: UK Data Has Been Weak

UK CPI and sentiment July

Bilal Hafeez is the Editor of Macro Hive and can be contacted here

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)

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