Morning Brief – Head above water

Head above water

GBP has struggled in recent weeks to find new momentum. Thanks to its somewhat meteoric rise so far this year, this lack of sustained upward price momentum has fuelled second guesses of a correction in the UK currency. Sterling’s range bound existence on a trade weighted basis this month has allowed Sterling bulls to unwind portions of their long bets in favour of the Pound and to take profit. The problem for navigating the immediate future of GBP lies in the fact that fundamentals lie in favour of buying the currency, but it’s lofty price, at least compared with its intra-pandemic valuation creates conflicting forecasts. Ignorant of price therefore, Sterling’s a no-brainier: a world-leading vaccination programme, inflation outpacing expectations, lower political post-Brexit risk (just about!) to name only a few. But inclusive of price, it’s a more challenging picture: does GBP still hold upside growth despite an 8% rally year to date?

Spoiler alert: yes, probably.

When the UK announced a Brexit deal on Christmas Eve, the Pound didn’t jump. This was to the surprise of many who supposed that given more than four years of blaming the 2016 referendum and the subsequent negotiating period for undermining GBP, the removal of a significant proportion of the political obstacle should allow for a smooth advance higher. In fact the only thing that shifted immediately was the year-end overnight borrowing/swap market in Sterling in a colossal risk adjustment market-wide shift. This did not, however, translate into spot, like-for-like valuations. This was partially because the deal failed to satisfy those with high hopes of a strong trade deal and the swift reminder of other political risks that had been created or still remained as a result of the process: queue Sturgeon, Farage, Juncker, Barnier & co. Rather the adjustment in GBP was a slow burner with evidence of money moving back into the UK and a reallocation of capital onto UK shores throughout 2021 to date. As the post-pandemic environment facilitates higher levels of productive capital allocation, there’s a lot of reasons to suggest GBP will be a beneficiary of this.

So if pricing, levels and technical factors are what might stand in the way of a rising GBP, how is GBP strength still the likely base case? The answer is GBP finally, after an 8% rally this year, has its head above water. The post-referendum channel bound trade weighted GBP has finally, seemingly, been broken and only now does the Pound have the technical case to support further appreciation despite its sharp rally and historically lofty valuation. With the range broken, GBP should have the floor upon which to navigate a post-pandemic, post-transition environment higher. Due to the valuations in GBP, and the combined fragility of the post-Brexit trade deal and the post-pandemic recovery period, this case will be regularly challenged and frequently volatile.

Discussion and Analysis by Charles Porter

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