The best of 2018 may already be over for the pound

  • The pound has appreciated aggressively against the dollar in 2018, partly down to weakness in the US dollar.
  • Part of its strength has been related to rising market expectations that Britain will avoid a hard Brexit.
  • That means that much of sterling’s rally for the year is over, and sterling could be fairly boring for the rest of the year, according to Samuel Tombs of Pantheon Macroeconomics.

LONDON – The pound‘s aggressive rally at the start of 2018 may now be over, and the rest of the year could be pretty calm for the currency, analysis from research house Pantheon Macroeconomics suggests.

Writing in a note to clients published on Tuesday, Samuel Tombs, Pantheon’s chief UK economist said that following the rally that has taken the pound above 1.40 against the dollar, that he now does “not see scope for a major shift in sterling this year.”

That’s down to the fact that markets have now largely priced in any possible Brexit good news – which is in the eyes of the market a soft Brexit – and sterling has appreciated accordingly. Now that’s out of the way, the pound will plod along for the rest of the year.

“With this good news now largely priced-in, though, sterling probably won’t continue to ascend rapidly,” Tombs writes.

“We see sterling slipping back to about $US1.38 by mid-2018, as the pace of monetary tightening in the U.S. exceeds investors’ expectations. But we expect sterling to rise against the euro gradually this year, ending 2018 at about €1.20, as the Eurozone economy starts to disappoint investors very optimistic expectations.”

Tombs finds that the pound has now decoupled from the market’s expectations of interest rates in the UK – usually a key driver of cyclical currencies – as few Bank of England policymakers have spoken during 2018, so markets have had little to go on.

“Sterling has decoupled from markets’ interest rate expectations,” Tombs writes.

“Our third chart shows that sterling now is $US0.15 above the $US1.25 level implied by its relationship in the first half of this decade, with expectations for the difference between overnight interest rates in the U.S. and the U.K. over the next two years. The picture looks similar if expectations for interest rates over a longer period are examined.”

Here’s the chart mentioned above:

Screen Shot 2018 01 31 at 10.08.14Pantheon Macroeconomics

Sterling has gained several per cent against the dollar in just a few weeks, continuing the strong performance it saw towards the end of 2017.

Sterling, in fact, is the strongest performer in the G10 basket of major currencies over the past six months when compared to the US dollar.

Market consensus is that much of the pound’s recent rally is a story of a weak dollar than a strong pound, with the greenback dragged lower by a number of factors.

However, Tombs argues that the recent rally is “a story of genuine sterling strength too.” He points to the fact that “sterling hit a seven-month high against the euro last week and it has appreciated against nearly every other major currency.”

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