The race to the bottom with predictions of how low the pound can go continues.
Sterling is already hovering close to 31-year-lows against the dollar in the wake of the UK’s shock vote to leave the European Union, but on Thursday Deutsche Bank predicted the currency will fall much lower.
The investment bank forecasts that the pound will reach $1.15 against the dollar by the end of the year, against the current exchange rate of just shy of $1.30, and it reckons a euro will buy you 90p, up from its current rate of 85p.
The forecast follows an equally pessimistic call from Goldman Sachs earlier in the week, which said the pound could hit $1.20 soon.
Deutsche Bank’s George Saravelos says his forecasts “look aggressive”, but says: “Our assumption is that the UK is undergoing an unparalleled negative “terms of trade” shock, which requires GBP to reach historical (under)valuation extremes. As the charts below show, there is much more to go before GBP is considered excessively “cheap”.”
Here are the charts:
PPP, the light blue line, stands for purchasing power parity, “which measures the exchange rate that equates the price of a “big mac” between two countries.” In other words, whether real prices of goods differ between nations.
The Bank of England and many Leave campaigners have made the case that the economic impact of leaving the European Union could partially be offset by the devaluing of the pound, which would make British goods and services cheaper to export.
But Deutsche Bank is saying the pound needs to go even lower for this to be true. The light blue line more or less matches up with the current exchange rate, but Saravelos’ argument is they need to deviate to encourage trade. Basically, British made goods need to get a lot cheaper before they become attractive to overseas buyers.
Aside from exports, Deutsche Bank also looks at where the pound would need to get to in order to stimulate inward investment — foreign buyers snapping up UK houses and companies. These targets are even more aggressive.
“A final metric is to look at the underlying value of assets. What is the level of the exchange rate that would make UK assets “cheap” again and thus keep attracting the capital inflows that are needed to finance the current account deficit? Here we look at the London housing market priced in both dollars and euros as a proxy for “international UK assets” and assume “cheap” would be a return of house prices back to the currency-adjusted levels seen in 2005. This requires a move up to 1.20 in EUR/GBP and down to down to 90cents in GBP/USD. Part of this can (and will) be offset by a drop in sterling house prices but even if we assume a 20% drop in house prices that would still require a sterling move close to our forecasts.”
In this formulation, both the euro and the dollar would be worth more than the pound for the first time ever. The closest the euro got to parity with sterling was in 2008 during the financial crisis when it hit 1.02271. The closest the dollar has come to parity with the pound was in 1985 when it hit 1.0438.
Mohamed El-Erian, the former PIMCO boss and now chief economist at Allianz, also warned in an interview with Reuters on Thursday that the £1 could soon be worth $1, saying: “If Plan B is delayed and/or it doesn’t involve much of a free trade set-up with the EU, it is not inconceivable for sterling to head to parity with the US dollar.”
Here’s how sterling looks today against the dollar:
And here’s the euro against the pound today: