The British Pound’s stellar gains in 2021 are not deserved, say analysts at one of the world’s most prominent investment banks, who warned in a recent research note that a “nasty fall back to reality” might await.
British Pound Coming in Strong
The Pound has risen to multi-month highs against both the Euro and Dollar and is the top performing G10 currency of 2021, as a combination of factors converge to trigger a rebound from the lows of the Brexit period.
Some of the reasons include expectations for a vaccine-lead sustainable unlocking of the economy ahead of other major countries and reduced expectations for negative interest rates at the Bank of England. Aiding this sentiment is the removal of Brexit uncertainties and the boosting of Sterling reserves at international central banks.
But analysts at HSBC say the currency is trading well above levels justified by fundamental factors that should mean it is anchored lower.
“GBP’s reach exceeds its grasp,” says Dominic Bunning, a strategist at HSBC in a recent briefing on the currency. “In our view that upward momentum is undeserved from a value perspective. The move in GBP has far exceeded that of other anchors which one would normally associate with currency outperformance.”
The HSBC analyst cites three factors that make the Pound potentially overvalued:
-“The UK’s economic recovery remains lacklustre compared to others. The HSBC UK activity surprise index is one of the few trending sideways, not up, showing that the economy is not outperforming expectations in the way the US or Eurozone are.”
-“UK forward rates have risen this year with negative rates being priced out, but the move has been largely in line with what has happened in other G10 rates markets, especially the US. As rate differentials are what should matter for FX, the rate move does not justify GBP’s significant rally.”
-“UK equities remain a laggard suggesting that it is not foreign equities inflows driving GBP outperformance.”
HSBC strategists recognise momentum behind Sterling as being powerful, but the currency will remain overstretched until the underlying fundamentals change for the better.
The Pound-to-Dollar exchange rate rallied to above 1.42 on Thursday while the Pound-to-Euro exchange rate breached 1.16.
At the time of publication the GBP/EUR has rallied 4.0% in 2021, with the GBP/USD going up 3.25%.
“Robert Browning once wrote “a man’s reach should exceed his grasp, or what’s heaven for?” For a currency, the danger in exceeding your grasp is not that you reach heaven but that you get a nasty fall back to reality when the momentum wanes,” says Bunning.
The Pound registered fresh multi-month highs not just against the Euro and Dollar on Thursday, but also against the Franc and Yen with little to suggest momentum is about to fade, although HSBC are not alone in questioning Sterling’s break-neck ascent.
Other analysts say that the rapid rally could be due to a cooling-off given some technical signals.
“Sterling continues its stellar run, breaching 1.42 vs the USD and 0.86 in EUR/GBP. The latter is reported to be linked to option related selling. In light of the recent moves most Sterling crosses are extending further into overbought/oversold territory, suggesting that a degree of caution may be required near term,” says Jeremy Stretch, an analyst with CIBC Capital Markets.
However, over the medium-term, CICB Capital Markets expect ongoing GBP gains as the prospect of a gradual re-opening of the economy in the second quarter of the year portends towards a consumer oriented boom.