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U.K.

Sterling's Post-Brexit Depression Looks Melodramatic

The U.K.'s economic prognosis has improved. The pound? Not so much.

One of the most tangible consequences of the U.K.'s June vote to quit the European Union was the immediate collapse in the value of the pound. The combination of a huge political upset -- which saw the resignation of a national leader -- and the prospect of a wounded economy drove sterling lower on the foreign exchange market in the immediate aftermath of the vote. Six months on, however, the reasons for the currency's depreciation seem less compelling.

The chart below shows where the pound is currently trading compared with levels just prior to the plebiscite. The rally from the October lows hasn't pared its losses by much; the currency is still down significantly. But at least some of the reasoning for traders and investors to be bearish on the pound have dissipated since then.

Still Depressed

Sterling's slump since the EU referendum

Source: Bloomberg

Domestic political risk, for example, disappeared almost immediately. Instead of a damaging fight for the leadership of the ruling Conservative Party after David Cameron's resignation, Theresa May was anointed prime minister without challenge as her various opponents fell by the wayside.

While the politics of negotiating an EU divorce will be anything but straightforward, there's little evidence that the Tory party is indulging in the infighting over Europe that's damaged it in the past. Moreover, while Monday's resignation of the U.K. ambassador to the EU, Ivan Rogers, means the loss of an experienced voice in the forthcoming negotiations, it does give May the opportunity to cement her authority by handpicking a diplomat to replace one she inherited from Cameron. Meanwhile, support for the opposition Labour Party is at its lowest in more than three decades. So, domestically at least, the U.K. political scene looks about as stable as can be.

On the economic front, the good news continues to roll in, confounding those (myself included) who feared the worst in the Brexit aftermath. Figures released Monday, for example, show U.K. manufacturing growing at its fastest pace since mid-2014 in December as the weaker pound boosted exports and helped the industry shrug off its post-Brexit dip:

Manufacturing Rebounds

IHS Markit Purchasing Managers Index

Source: IHS Markit via Bloomberg

(A reading above 50 signals expansion)

Moreover, economists who had marked down expectations for how the economy would perform in the first quarter of this year are starting to nudge their forecasts higher:

Not So Gloomy

Median expectation of economists for what U.K. growth will be in the first quarter of 2017 compared with fourth-quarter 2016

Source: Bloomberg

In tandem with that better outlook for gross domestic product growth, economists have downgraded the risk of the economy sliding into recession in one years' time to 25 percent, about half of what they feared after the Brexit vote:

Receding Recession Risk

Consensus forecast among economists for the likelihood of U.K. recession in one years' time

Source: Bloomberg's ECFC function

(Note: survey frequency was increased from September)

In a report published prior to the Brexit decision, the International Monetary Fund argued that the pound had been overvalued by between 5 and 20 percent in 2015, given the size of the country's current account deficit. It acknowledged, though, that a chunk of that alleged overvaluation had been unwound as the pound had depreciated by 7 percent by April 2016, relative to its 2015 average.

There's no doubt that the decision to quit the EU has cast a pall over the U.K.'s economic prospects. Growth will likely be slower than it would otherwise have been. Wage growth will remain subdued. And the futures market suggests there's about a 70 percent chance that the Bank of England will leave borrowing costs untouched by this time next year, retaining its emergency quarter-point cut to 0.25 percent in August.

So, yes, Brexit will be painful. But the ultra-gloomy prognosis that formed the economic backdrop to sterling's initial slump has been replaced with a more nuanced analysis. If the only information you had to hand was the U.K. economic outlook for now versus a year ago, you'd struggle to guess that the pound would be trading 17 percent lower against the dollar and 13 percent down versus the euro. Maybe it's time for the British currency to shrug off its 2016 depression and embrace what everyone says must be a better 2017. 

Mark Gilbert: Brexit's Pound Pessimism Is Overdone

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Mark Gilbert at magilbert@bloomberg.net

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    Therese Raphael at traphael4@bloomberg.net

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