A rally that had made the pound the best performing major currency against the dollar over the last month should push it through the $1.30 mark, analysts say, despite signs that Brexit negotiations could turn hostile.
Foreign exchange strategists have been lifting their forecasts for sterling since UK prime minister Theresa May’s decision last month to call a snap general election — a move that propelled the pound from the $1.25 level to $1.29.
Nomura this week raised its projection to $1.32 and said the currency could end the year above $1.37. Dutch bank ING said $1.35 as a year-end target was “not a particularly aggressive call,” while National Australia Bank reckoned an imminent move above $1.30 “should not come as a surprise”.
The key driver in propelling the pound up 3.5 per cent over the last month has been a fall in the risk premium attached to Brexit after the snap election extended the next parliamentary term three years beyond the end of the scheduled negotiations between the UK and the other 27 EU member states. Investors believe that cuts the likelihood of a disorderly exit.
For now, however, the leak of a testy Downing Street dinner with European Commission president Jean-Claude Juncker is helping peg the pound below the $1.30 — a level it last touched in September. Details of the dinner contributed to sterling’s decline to $1.2861 on Tuesday, and a Financial Times story on Wednesday that the UK’s Brexit bill could amount to $100m had a similar impact on the currency early on Wednesday.
Although the pound is down 0.3 per cent this week, leaving it hovering above $1.29 in early afternoon trading on Wednesday, Nomura strategist Jordan Rochester said market reaction to this week’s Brexit developments had been limited, suggesting that investors were “taking them on the chin and they are largely priced in”.
The options market reflects the broader reduction in risk premium attached to Brexit. Three-month risk reversals in the pound against the dollar — a measure of the premium required to sell rather than buy sterling — has fallen by around a third since January.
Richard Benson at Millennium Global Investments said there had been “a very marked decline” in sterling risk as implied by the option markets, “just at the very time that the rhetoric is getting nasty”.
The Brexit developments coincided with impressive data showing the manufacturing sector at a three-year high and stronger than expected construction activity.
“The data matter more than the deteriorating Brexit negotiations”, said Société Générale’s Kit Juckes, but “frustration seems guaranteed for now”.
Shifts in positioning data are encouraging analysts to forecast that sterling’s rally will continue. Hedge funds slashed sterling shorts by around half in one week last month, according to the most recent data compiled by the Commodity Futures Trading Commission, their lowest level since the June referendum before which sterling was trading at around $1.50.
“ . . . position liquidation is already well under way,” said MUFG currency analyst Lee Hardman, a move which he said could lift sterling to $1.30 to $1.35.