GOLDMAN SACHS: If we're right, the pound should fall another 10%

The pound, which has already dropped to a 31-year low against the dollar, has much further to fall, according to new research from Goldman Sachs circulated on Tuesday evening.

In a note titled “What is Fair Value for the British Pound?” — Goldman analysts Robin Brooks, Silvia Ardagna, and Michael Cahill argue that sterling is actually still overvalued by around 10%, despite dropping more than 17% in the four months since the EU referendum.

Many currency models now illustrate that sterling’s massive crash since June 23 means it is cheap in the grand scheme of things, passing well below the levels it should be at as a result of the political uncertainty that has plagued the country in recent weeks, following the first suggestions that we are heading for a hard Brexit — leaving the EU without any formal trade deal with the bloc.

However, on the flipside, Goldman says that sterling is not actually overvalued, thanks largely in part to the substantial shift in the country’s current account deficit that has come about from sterling’s recent falls. “Putting this together, we find that the Sterling depreciation through October has probably taken the underlying current account deficit from just over 6 per cent to about 3.3 per cent,” Goldman says.

Here’s the key extract from Goldman’s analysis of why sterling has further to fall:

“The signal that Sterling is cheap therefore ignores the ructions that Brexit may cause for the UK economy and — potentially — a drop in fair value.”

“As a result, we use a different approach, which calculates the depreciation needed to bring the current account to a new, post-Brexit equilibrium. That approach says that GBP needs to fall between 20-40 per cent from pre-Brexit levels, so the declines since June have only brought us to the lower bound of this range.”

And here’s Goldman’s chart:

Sterling crashed on Tuesday afternoon, falling more than 1.2% seemingly with little catalyst other than comments from Chancellor Philip Hammond in the House of Commons that he sees “no reason” why he would necessarily reject any future requests from the Bank of England for further quantitative easing.

It then recovered as BoE Governor Mark Carney appeared in front of the House of Lords Economic Affairs Committee to give the committee an update on the progress of monetary policy in the UK. Topics included the BoE’s response to the UK’s Brexit vote, and whether Carney will leave his post in 2018, or stay for a full term until 2021.

On Wednesday, sterling has picked up a little gaining around 0.2% as of 9.55 a.m. BST (4.55 a.m. ET):

NOW WATCH: Wells Fargo CEO John Stumpf is retiring, effective immediately

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.