BANK OF AMERICA MERRILL LYNCH: The pound is due another big dip before it starts to recover

LONDON — The pound is set for one final big dip against the dollar once Britain triggers Article 50, before finally starting a meaningful recovery into the end of 2017. 

That is according to Bank of America Merrill Lynch Strategist Kamal Sharma in a note circulated to clients on Thursday.

Sharma argues that while Brexit is not yet fully priced in by the markets, the pound should start to recover in the months after Article 50 is triggered as it will end up looking “cheap relative to its medium-term drivers.” 

“Whilst we would agree that A50 triggering is a fait accompli, we disagree that GBP is fully priced for the ebb and flow of forthcoming negotiations,” Sharma writes.

BAML’s key argument for an upcoming fall in sterling is that they believe confidence in Brexit negotiations going smoothly and as planned is misplaced, and that there could be a rocky road ahead.

Here is the key quote from Sharma (emphasis ours):

“We think that the near-term bias remains asymmetric – that markets are too complacent in expecting a smooth transition towards negotiations and the final agreement. Our view on GBP vulnerability to Brexit news flow is supported by price action following news headlines this week regarding the possibility of a second Scottish Referendum and the EU’s tough stance on equivalence for the City of London. We therefore stick to our call for one final dip in GBP/USD before a recovery into the end of the year as sterling is cheap relative to its medium-term drivers.”

The bank does caveat its forecast however, acknowledging that if things go well, and that Britain and the EU provide any indicators early into talks about their final outcome, sterling could jump.

“Any hint that both the UK and EU are providing certainty and clarity beyond the two-year negotiating period early into the negotiations would be extremely GBP bullish, challenging our near-term bearishness,” said BAML.

Opinions on the pound’s relationship with the dollar differ wildly right now, with many more pessimistic analysts forecasting a substantial further drop in sterling’s value.

In February Deutsche Bank’s global co-head of FX research, George Saravelos said in an interview that the bank sees sterling falling another 16% to as low as 1.05 against the dollar, as the “incredibly complicated” nature of Brexit becomes ever more clear.

On the other hand, Morgan Stanley argued last week that sterling should appreciate to the levels seen in the day’s before Britain voted to leave the European Union by the end of 2018.

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