This article was written by Justin Yang. It appeared first on the Bloomberg Terminal.
The U.K. just got a new government, the Bank of England held off from a knee-jerk interest-rate cut and the pound posted its best rally in four months. Yet strategists say these are merely the opening chapters of a post-Brexit saga that has further losses in store for the nation’s currency.
Sterling will slump almost 4 percent by year-end to $1.27, according to the median estimate of its 10 most-accurate forecasters, all of whom have revised their predictions since the June 23 vote to quit the European Union. Options traders are more pessimistic on the pound than any of its major peers.
There are too many questions still to be resolved about Britain’s relationship with its European neighbors for strategists to be optimistic on sterling. With Prime Minister Theresa May signaling she’ll wait until 2017 before triggering the formal EU exit procedure, companies’ investment decisions could be delayed for months and consumer confidence may be hurt by the lingering political instability. Plus, there’s the potential for the BOE to introduce a raft of stimulus measures in less than three weeks that would probably weaken the pound.
“There will still be a lot of uncertainty into 2017, especially about what’s going to happen about investment, what’s going to happen about the banking sector,” said Kristian Schmidt, a currency analyst in Silkeborg, Denmark at Jyske Bank A/S, ranked seventh in Bloomberg’s most-recent pound-dollar rankings. Those are the things “to keep an eye out for’’ on the currency this year and next, he said.
The median year-end pound forecast of the top 10 forecasters is almost a cent weaker than the 31-year low of $1.2798 set on July 6. Jyske Bank’s prediction of $1.25 is even more bearish. That compares with $1.3220 as of 7:37 a.m. London time on Monday, after a week in which Britain’s currency rallied 1.8 percent, its best performance since March.
Markets are yet to see any major data reflecting the state of the economy since the EU vote. The U.K.’s statistics office says inflation figures due Aug. 16 will be the first to shed light on how the country is faring since the referendum, while strategists warn that the lack of clarity surrounding the Brexit procedure will maintain pressure on the currency.
“This could be a pound-negative, this sort of political uncertainty about what Brexit will look like,” said Petr Krpata, London-based chief currency strategist for Europe and the Middle East at ING Groep NV, which was fourth in Bloomberg’s forecaster rankings and sees a year-end level of $1.25. “We still expect the Bank of England to ease monetary policy further, and that’s a negative. More importantly, the U.K. is running a very large account deficit.”
The shortfall in Britain’s current account, which is equivalent to 5.4 percent of gross domestic product and compares with a surplus across the EU, is one of the reasons quitting the world’s largest trading bloc is potentially so perilous for the nation’s economy.
To address the risks, action from the BOE is widely anticipated. Even as it unexpectedly held its benchmark rate at a record-low 0.5 percent last week, the central bank signaled it’s likely to ease policy at its next decision on Aug. 4. Futures are pricing in about a 70 percent likelihood of a quarter-point rate cut at that meeting, and also suggest there’s a better than one-in-three chance of the main rate being lowered to zero before the year is out.
All but one of the most-accurate forecasters cut its predictions since Brexit. Top-ranked Svenska Handelsbanken AB raised its outlook to $1.31 from $1.29 on the day of the referendum because it sees the vote delaying a Federal Reserve rate increase and hurting the dollar.
Forecasters across the market are bearish on sterling. Goldman Sachs Group Inc. reiterated a year-end estimate of $1.20 last week, citing a lack of clarity about the Brexit talks, while HSBC Holdings Plc cut its year-end prediction to the same level. Fellow U.K. lender Standard Chartered Plc is even more bearish, at $1.18.
Options traders are paying a 2.1 percentage-point premium for six-month contracts to sell the pound versus the dollar over those to buy, data compiled by Bloomberg show. That’s more than for any of its Group-of-10 counterparts, though the extra cost has fallen steadily to about the lowest since February.
Neil Mellor of Bank of New York Mellon Corp. is looking to history for inspiration.
The pound’s 4.1 percent slide on Black Wednesday in September 1992 — when the U.K. crashed out of Europe’s exchange-rate mechanism — was only about half the 8.1 percent drop on June 24. But the London-based strategist said the event is the only episode in recent U.K. history that’s comparable with Brexit.
After a week of losses more than two decades ago, the pound rallied as much as 7 percent from Sept. 23 to 30, before resuming its slide to lose 20 percent in the following five months. Mellor says headlines at the time showed markets judged the crisis to have been over.
“The recovery belies the plunge in ’92 that took place,” Mellor said. “I wouldn’t say it’s a parallel — but I’d say it’s a warning.”