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The risk of an interest-rate cut as early as this month seems no impediment to a stronger pound.
Sterling is predicted to steadily climb for most of 2020, ending the year around 3% stronger than current levels against the dollar. That argument is based on a relatively smooth U.K. exit from the European Union, drawing capital inflows into sterling assets, and resonates with the pound’s turnaround from its decline after BOE policy makers pointed to potential rate cuts.
Most currency analysts think that if the central bank were to lower borrowing costs not only would it be a one-off move, but it could help the U.K. economy and in turn end up supporting the pound. The currency sagged this month after a spate of comments by policy makers calling for stimulus, ending market euphoria over the Conservative Party’s resounding election win in December.
“If the BOE are to cut interest rates by the end of this month, it’s seen more as a risk management move to try and solidify expectations for a rebound in growth going forward,” said Lee Hardman, a currency strategist at MUFG Bank Ltd.
The pound is trading around $1.31 Thursday, having recovered from a drop below $1.30 earlier this month after BOE Governor Mark Carney said there’s room to expand quantitative easing. Money markets now see about a 58% chance of January rate move, with the focus turning to Friday’s U.K. manufacturing and services data for clues on what policy makers will announce on Jan. 30. The yield on 10-year gilts slipped to 0.6%, the lowest since October, before stabilizing at 0.62%.
While a January cut would be earlier than Hardman’s prediction of a move in May and could mean some near-term pressure on sterling, he doesn’t see the currency significantly weakening, given subsiding Brexit risks. His end-year call is $1.34, close to the Bloomberg survey median of $1.35.
“Even if you say it is potentially a temporary respite, I don’t see Brexit risks flaring back up again any time soon,” he said. “That is a key component as well on why the pound is stabilizing at higher levels.”
Prime Minister Boris Johnson’s Brexit deal cleared its final hurdles in Parliament Wednesday, paving the way for Britain to leave the EU in eight days.
Option markets also point to relative calm for sterling’s outlook. Gauges of sentiment and positioning for the next month are in favor of pound gains and the most positive since October. Bets on swings over one year, covering the end of the Brexit transition period on Dec. 31, have cratered to levels last seen in 2014.
Not everyone is bullish. Sonja Marten, currency strategist at DZ Bank AG, was one of the top forecasters on the currency in the last quarter, according to rankings compiled by Bloomberg. For the year ahead, she is among the most pessimistic on its 2020 trajectory, seeing the currency finishing at $1.24 -- a level not seen since before a breakthrough in Brexit negotiations back in October.
“The EU will not begin negotiations with the U.K. before the end of February, which leaves preciously little time to negotiate a free-trade agreement,” Marten said. “Our base-case scenario is still that there will be some form of agreement by the end of the year, but it’s likely to be a very last minute agreement, so the relief rally won’t happen before the very end.”
Still, most forecasters are banking on a respite for sterling. The pound is set to rally 7% to end 2020 at $1.40, according to Ned Rumpeltin, the European head of currency strategy at Toronto-Dominion Bank. That punchy outlook is despite him seeing some near-term weakness as he predicts the central bank lowering interest rates twice in the first half of 2020.
“On a longer term perspective, we are more constructive on the pound,” London-based Rumpeltin said. “The rate cuts we expect from the BOE this month and in May will support growth. At the same time the U.K. will begin to attract capital inflows given sterling’s attractive valuation.”
(Updates prices throughout, adds details on gilts in fifth paragraph.)
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