CBA reckons there's plenty of upside to come for the British pound in the short-term

Photo: Matt Frost/ITV via Getty Images

The British pound rallied overnight — something it hasn’t done much recently.

Helped by a ruling from the British High Court that the UK Parliament must vote on triggering Article 50 of the European Treaty to pave the way for Brexit, along with a hotter-than expected economic data and an upward revision to the Bank of England’s inflation forecasts, the pound soared, rising to as high as 1.2494 against the US dollar before easing in US trade.

In early Asian trade on Friday, the GBP/USD currently fetches 1.2462.

GBP/USD 4-Hour Chart

After such a dramatic move, nearly 1.5% higher than Wednesday’s closing level, the question everyone is asking themselves now, at least in terms of the currency, is can the pound continue its march higher?

Yes, it can, says Peter Dragicevich, senior currency and rates strategist at the Commonwealth Bank, citing extreme short positioning among currency traders as one factor that could see the pound rip higher in the short-term.

“UK political developments and the shift in stance by the Bank of England (BOE) Monetary Policy Committee (MPC) have combined to give GBP a boost, said Dragicevich in a note released on Friday. “In our view, as participants continue to digest these developments, the paring back of the still large net short GBP positioning should see GBP continue to squeeze higher in the short-term.”

This chart from the CBA shows current non-commercial futures positioning in the pound based found in the the weekly Commitment of Traders report released by the US Commodity Futures Trading Commission.

It’s expressed as a deviation from its long-run average, and at present positioning is very short, indicating that traders are expecting further pound weakness. Non-commercial positions are used as it reflects the view of currency speculators, not those using futures for hedging purposes.

So how far does he see the pound squeezing higher in the short-term? Quite a bit, in short.

“We think GBP/USD can bounce towards the 50-day moving average (1.2755) or possibly above, depending on the outcome of the 8 November US Presidential Election, before petering out,” he forecasts.

Dragicevich also believes that the pound should also recover lost ground against the Australian dollar and euro as positioning is adjusted.

“EUR/GBP in particular stands out in our view, given the large gap that has opened up between the actual level and our modelled estimate constructed from the two-year swap spread differential, relative data surprise indices, and a ratio of banking stocks,” he says.

While Dragicevich is bullish short-term, he still expects it to underperform longer-term, saying that the he still expects Brexit to happen in one way or another.

“The impact of the UK leaving the EU, higher UK inflation, and weaker business investment will dampen growth momentum over 2017 and beyond,” he says. “Added to these problems is the fundamental GBP headwind generated by the UK’s persistently large current account deficit, currently 5.7% of GDP.”

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