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Pound traders are making a costly mistake to assume a dovish US Federal Reserve will prompt the Bank of England (BOE) to delay raising interest rates, according to the biggest sterling bull.
UniCredit predicts Britain’s currency will strengthen 6 per cent to US$1.65 by the end of the first quarter of next year, making it the most optimistic forecaster in data compiled by Bloomberg, which has a consensus view for a slight decline.
Italy’s largest lender says the Fed will increase rates in December, with the Bank of England following two months later.
That is a contrast to the futures market, where traders are not anticipating a BoE lift-off until late 2016 after the Fed stood pat on monetary policy last week. Higher interest rates tend to boost currencies because they enhance the allure of financial assets.
“The process of policy normalisation in the UK will start sooner than the market expects,” said Roberto Mialich, a Milan-based senior foreign exchange strategist at UniCredit. “Sterling will remain on a relatively firm tone.”
Britain’s currency has see-sawed against the dollar this year as investors and traders struggled to pinpoint when officials led by the BoE governor Mark Carney would raise rates. The timing of the Fed’s first increase since 2006 is important as it may provide the BoE with the confidence to follow its US counterpart following an extended period of exceptionally low rates.
UniCredit has had a mixed track record in forecasting the pound this year. Like most other contributors to Bloomberg’s survey, it failed to predict sterling’s 5 per cent decline versus the dollar in the first quarter, although it correctly forecast a second-quarter rally.
Britain’s currency advanced to a seven-month high of $1.59 in June, but has fallen since then as sluggish consumer spending and vanishing inflation dampened investors’ confidence in an early rate increase. Those ups and downs have left sterling little changed this year. It was trading at $1.52 in London on Wednesday.
Mr Mialich says the pound will strengthen against the dollar because higher US borrowing costs are already factored into markets, while a boost to UK ratesis not.
Gains would be a blow for hedge funds, which turned positive on the pound versus the dollar for the first time in almost a year in August, only to reverse that net position this month, according to the commodity Futures trading commission in Washington.
Political risks
Speculators are not the only ones convinced the pound is headed lower.
Focusing only on “short-end differentials” is misguided, according to Hamish Pepper, a foreign exchange strategist at Barclays, the most bearish forecaster in Bloomberg’s survey and the world’s third-biggest currency trader.
He is more concerned with “government-related risk”, including the new administration’s spending cuts and forthcoming referendum on Britain’s membership of the European Union. “Monetary policy itself isn’t everything,” Mr Pepper said.
“The UK will be firstly lagging the US in terms of growth, inflation and ultimately monetary policy. But on top of all of that it will be facing this substantial tightening of fiscal policy at a time when there’s uncertainty about whether the UK will remain part of the EU.”
Most pessimistic
Barclays predicts the pound will tumble to $1.43 by the end of the first quarter of 2016, the most pessimistic of 57 estimates compiled by Bloomberg. At the other end of the spectrum, UniCredit’s prediction is 7 per cent stronger than the $1.54 median forecast.
The Italian lender is less optimistic on the pound versus the euro, expecting it to remain little changed at 72 pence, compared with Barclays’s estimate of a rise to 67 pence, and the 69 pence median.
Forward contracts based on the sterling overnight index average, or Sonia, suggest that a full quarter-point increase to the BoE’s 0.5 per cent official rate will not come until November 2016. That compares with the August increase signalled before the Fed’s meeting ended on September 17.
As well as keeping US rates at a record low, the Fed chairwoman Janet Yellen and her colleagues published a statement that referenced the turmoil in global markets and slow inflation as reasons for their decision.
The BoE chief economist Andy Haldane made similar arguments last week in a speech where he said that the case for raising UK rates is “some way from being made”.
Top forecaster
Ebury Partners, the most accurate euro-sterling forecaster in Bloomberg’s second-quarter rankings, says it is considering raising its short-term estimates versus the dollar because the Fed’s rate decision will not delay the BoE.
As of early September, the advisory firm forecast a drop to $1.49 and an advance to 67 pence per euro by the first quarter.
“The Fed’s no-show in September should be good news for sterling in the immediate term,” said Enrique Diaz-Alvarez, the chief risk officer at Ebury in New York. “Provided we continue to see a strong economic recovery in the UK – particularly in the labour market – a BoE rate hike in early 2016 is still most certainly on the cards.”
Meanwhile, Goldman Sachs says the euro may fall up to 10 US cents as the European Central Bank (ECB) is set to increase currency-weakening stimulus to meet its inflation target.
The investment bank predicts the ECB will maintain quantitative easing at its current pace of €60 billion (Dh245.2bn) a month through the end of 2016, an extension of the plan that was intended to run until September 2016, and only end it completely in mid-2017.
“This represents a material upsizing of the original programme me and should weigh on the single currency,” said Goldman Sachs analysts, including Robin Brooks, chief currency strategist in New York. “Depending on how credible an upsizing to ECB QE is, we therefore see scope for euro to fall between six and 10 big figures,” they wrote, referring to a drop of six to 10 cents.
The shared currency fell 0.04 per cent to $1.11 in London on Wednesday.
Hedge funds and other money managers boosted net bearish bets on the euro for the third week in the period ended September 15 to 84,202 contracts from 81,241, according to data from the commodity futures trading commission.
Very different
The euro slid last week as Benoit Coeure, an ECB executive board member, said that US and Europe’s policy trajectories will “remain very different”. Mr Coeure and the executive board member Peter Praet are scheduled to speak on Monday, followed by the ECB president Mario Draghi taking part in a European Parliament hearing in Brussels on Wednesday.
Mr Coeure’s comments suggested “the Fed reaction was a tactical pause and that the ECB stands ready to do more,” said Sam Tuck, the senior currency strategist at ANZ Bank New Zealand in Auckland. “Euro-dollar will be under pressure on those sort of fundamentals.”
The euro has strengthened 3.7 per cent in the past three months, the third best performer of 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes.
The yen was the best, rising 6.6 per cent, and the dollar appreciated 4 per cent.
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