A transition deal means a slower journey to a bad destination so if an agreement is struck in the new year, it will be unlikely to boost the economy’s performance.
The Pound is likely to weaken against the Euro in 2018, according to strategists at Morgan Stanley, as the economic backdrop in the UK remains challenging and an eagerly anticipated “transition deal” in Brexit negotiations will only be sufficient to avoid a further downturn.
A transition deal will mean only a slower journey to a bad destination and so an agreement being struck in the early stages of the new year will be unlikely to lift the economy’s performance.
“We retain our GBP-bearish bias. Positioning in GBP remains long, which suggests downside risks,” says Hans Redeker, head of G10 foreign exchange strategy at Morgan Stanley.
This leaves Sterling vulnerable to a further fall over the broad stretch of the year ahead. Morgan Stanley foreign exchange forecasts suggest the likely fall could be as much as 7% - enough to put a dent in anybody’s pocket.
“Also, data have surprised to the upside, as seen in manufacturing PMIs and house prices. However, the broader backdrop of high inflation, negative real incomes and accommodative BoE policy renders GBP likely to weaken,” Redekker adds.
The UK economy has shown signs of regaining some of its lost momentum in recent months, with GDP growth in the third-quarter coming in at 0.4%, up from the 0.3% seen in the first and second quarters.
This tentative rebound has been powered largely by an uptick in consumer spending which has continued well into the fourth-quarter. November’s retails sales growth came in at 1.1%, which was far ahead of the consensus for an increase of 0.4%.
“EURGBP is trading at the lower end of the trend channel, suggesting potential upside risks, and we watch the 0.88 figure closely to gauge near-term momentum,” notes Redeker.
However, much of the November increase in consumer spending was the result of Black Friday sales and many strategists and economists have doubts over whether it can continue into the New Years.
“When vol breaks higher, currencies with foreign funding needs (either because of external liabilities or because of a current account deficit) will suffer most. GBP and CAD have the widest current account deficits within the G10, while AUD and NZD run high external liability positions,” warns Redeker.
Global factors are also important in determining where the Pound will head next, with faster growth elsewhere likely to reduce the relative attractiveness of the UK as an investment destination, while the withdrawal of central bank stimulus from global markets could also present its own set of challenges.
“With global central bank liquidity set to begin declining, it will be the evolution of private savings that must be watched as the marginal driver of the risk outlook,” says Redeker.
The Bank of England raised interest rates for the first time in a decade in November, taking the base rate up by 25 basis points to 0.50%, while the European Central Bank is on the verge of winding down its quantitative easing (bond buying) program.
“These savings in Japan and the euro area decreasing, as consumption in these areas rise, may be the starting point for higher volatility and risk assets moving lower,” the strategist adds.
The Federal Reserve is also expected to begin shrinking its balance sheet in the New Year, which is something that will see the central bank playing a reduced role in the bond market.
“We would suggest that being long EUR and JPY against AUD, NZD, GBP, and CAD should do well into 2018,” says Redeker.
The Morgan Stanley team are betting the Pound will fall against the Euro and Japanese Yen in the year ahead. They forecast that the Euro-to-Pound rate will rise to 0.9400 by the end of the year, which puts the Pound-to-Euro rate down at 1.0638.
The Pound-to-Euro rate was quoted 0.06% higher at 1.1340 during early trading in London Monday.
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