DEUTSCHE BANK: 'The pain's not over for the pound'

The British pound has further to fall in the aftermath of the UK’s decision to leave the European Union, despite dropping to its lowest level against the dollar in more than three decades, according to new research from analysts at Deutsche Bank.

Sterling dropped from being worth just less than $1.50 on the day Brits went to the polls in June to around $1.30 now, having fallen as low as $1.28 during August.

That is a fall of almost 13%, and as S&P noted earlier on Wednesday, a fall of nearly 17% in real terms.

However, there is more room for downside in the pound, according to Deutsche’s Oliver Harvey, who notes that: “Despite the largest fall in history since the Brexit vote, there is little cause for optimism on sterling.”

“The pain’s not over for GBP. With data surprises close to record highs, fiscal easing unlikely to help, political risk rising and the flow picture very negative, we remain bearish,” Harvey continues.

Harvey argues that even though Britain has seen a variety of better than expected economic data releases in the past couple of months, the only real direction sterling will travel going forward, is downwards. He provides several reasons for that prognosis, and we have decided to pick out the three which provide the clearest picture of why sterling is set to decline even more.

First, Harvey notes that the prospect of fiscal stimulus — while likely to help out the British economy in some respects — will not necessarily be good news for Britain’s currency. Here is Harvey (emphasis ours):

“There is speculation that Chancellor Hammond will announce an easier fiscal policy at the Autumn Statement, but this won’t necessarily be pound positive. Historically, sterling has been positively correlated to the budget balance. This isn’t just a function of growth — a simple regression of the OBR’s measure of the change in the cyclically adjusted budget deficit since the 1970s shows a negative, albeit loose, relationship between easier fiscal policy and sterling performance.”

Second, Deutsche Bank’s view is that while economic data in recent weeks and months has been better than might have been expected, and the British economy has stood up well to the shock of Brexit, things still suggest that growth in the country is going to be pretty terrible in the coming year or so.

Harvey argues:

“Despite the bounce in the PMIs and moderate upward revisions to some official sector growth forecasts, the UK’s composite PMI still implies growth in Q3 around 0%, hardly stellar performance. Moreover, better data appears partly due to transient benefits from a weaker exchange rate.”

And here is his chart, illustrating just that:

Harvey’s third argument is that the political risks associated with Brexit are now “back-loaded.” Essentially, while the UK avoided a major political crisis in the summer by appointing a new prime minister very quickly, turmoil is on the horizon, made worse in part by the tiny majority that Theresa May’s government has. Here is Harvey once more:

“Recent government statements suggest the UK is preparing itself for loss of access to the Single Market, perhaps due to pressure from the Conservative Party’s hard-line Euro-sceptic MPs. Prime Minister May’s parliamentary majority is the smallest since Harold Wilson in 1974, a government ultimately brought down by a vote of no-confidence. With French and German elections in the spring and autumn of next year, political noise is likely to rise.”

Deutsche Bank is not the only institution backing a further fall from the pound, with some predictions suggesting that sterling and the dollar could even reach parity. Most forecasts, however, put sterling’s bottom at somewhere around $1.15-$1.20, marking a fall of between 7.7% to 11.5% more.

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