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Cheaper Pound May Challenge Case for Currency's Darker Outlook

Updated on
  • Sterling is 19% undervalued against dollar on purchasing power
  • Less need to hedge against pound fall over one year, says ING

The pound is looking increasingly cheap.

The currency is currently undervalued by around 19 percent against the dollar and by 8 percent against the euro, according to the Big Mac purchasing-power parity model. Sterling rebounded on Thursday after a report showed U.K. retail sales rose more than expected in April, heading above $1.34 after falling on Wednesday to $1.3306, the lowest level this year.

Cheap Pound

Sterling is the most undervalued Group-of-10 currency barring the yen

Source: Bloomberg

Note: Values as of May 24 2018. Base: U.S. dollar

“The very weak valuation by historical standards makes investors hesitant to believe in more structural sterling downside,” said Andreas Steno Larsen, a currency strategist at Nordea Bank AB.

While Brexit continues to loom as a risk, the transition agreement signed earlier this year has lowered the threat of the U.K. leaving the European Union without any sort of deal, removing a reason for longer-term pound pessimism. One-year euro-sterling risk reversal option contracts, a measure of market positioning and sentiment, are the least negative on the pound in 11 months.

“The need to hedge a sharp pound depreciation over a one-year horizon is much lower,” said Viraj Patel, a currency analyst at ING Groep NV.

(Updates prices and adds details on retail sales data.)
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