Reflections

FX Outlook: Less than Sterling

Posted:
3 Dec 2021
Author:
George Brown

GBPUSD

It feels like we’ve been left at the altar numerous times in our belief that the pound will gather itself to make an assault on perceived fair value of 1.5000+, last seen the night before the Brexit vote back in 2016. Political events and the pandemic have created unforeseen circumstances that have not only hampered the UK’s growth but also significantly weakened the reputation of sterling, with no immediate signs of change as we move in to 2022. The likelihood that sterling will not totally shake the reputation it has been tagged with in the last year or two, of trading like an emerging market currency, leaves us resigned that the year to come could be another year of subdued demand for sterling.

Even if the risk is slightly weighted to the upside for GBP, considering the likely rapid return to growth and rising interest rates as inflation appears that it may settle in for longer than expected, it will still have to tackle a pretty resilient US dollar if it does want to ascend towards 1.4200, where GBPUSD peaked in 2021. The US economy has managed to sustain some momentum in the aftermath of COVID-19 and is gathering further support as the taper of their quantitative easing operations kicks in, laying the foundations for rate hikes in 2022.

GBPEUR

Whilst we’re, at best, cautiously optimistic on the sterling outlook for 2022, we believe the single currency will remain under pressure over the next 12 months which could pave the way for GBPEUR to break the pre-covid high of 1.2046. Whilst this is not certain given the UK backdrop we certainly expect GBPEUR to remain at elevated levels versus the average of 1.1400 over the last five years.

Currency markets are notoriously short-term in their thinking, right now the euro is sitting against the backdrop of a fourth wave, they have had negative rates for over seven years (which doesn’t look like changing any time soon) and the usual political fragmentation which has plagued confidence in the zone for the last ten years. Therefore, on paper the battle between GBP and EUR is a mismatch, particularly as we do expect the pound to gather some momentum from the recovery, from a position of being undervalued on a long term basis.

What could spoil the party for GBPEUR to remain at the top of the five year range where it currently finds itself in the 1.19’s? Well, to start, lets remember that the pound has not been the most reliable of late and Westminster is less predictable than ever, as is the shape and performance of an economy and workforce that has been ravaged by the pandemic. From the Eurozone, the political outlook, economic performance and the monetary policy expectations are all on the wrong side of positive, so there is room for improvement and therefore a positive swing in sentiment towards the single currency.

All considered, with our view that the pound will remain resilient if anything other than spectacular, we think GBPEUR has every chance of remaining at elevated levels and not returning to the single digits we saw in 2021.

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