It took a North Korean ballistic missile launch and Hurricane Harvey’s devastation of the $500 billion Houston/Galveston/Corpus Christi economy to push sterling higher to 1.2950 against the US dollar. While the British pound is the most undervalued G-10 currency on any purchasing power parity or econometric criteria, its upside is limited by deteriorating UK economic data and the clear perception that the EU will exact a draconian divorce settlement before negotiations on trade or post-Brexit UK access to the common market can even begin.
Sterling has benefited from the 9% plunge in the US Dollar Index, disillusionment with Trump’s pro-growth legislative agenda and the falling odds of a Federal Reserve monetary tightening move until December 2017. Political risk and a sluggish economy have both hit psychology on sterling, even though the British currency is now priced for a ‘hard Brexit’ scenario. However, the phenomena of foreign exchange trends overshooting fundamental value zones has been a recurrent trend of post Bretton Woods foreign exchange markets and sterling bear markets have been swift and vicious, as the world learnt the hard way on Black Wednesday 1992. Yet the latest (2007–2017) sterling fall from 2.10 to 1.29 on cable has been the most severe in the financial history of the sceptred isle, worst on a trade weighted index than the ERM exit (1992), the Harold Wilson devaluation (1968) or British Empire’s exit from the gold standard (1931).
However, it is not prudent to challenge the bearish sterling trend, particularly against the euro or high yield currencies like the Indian rupee and Turkish lira. Theresa May has made a strategic error in her silence on the Brexit settlement bill and the right of EU citizens settled in the UK – and sterling will bear the cost of her silence. There is no way Michel Barnier can discuss a trade deal amid this silence. Nor can UK economic data. High street spending, capex, inflation, real wage growth, offshore capital flows, the current account deficit – reinforce the sterling bulls.
With sterling now at its lowest level against the euro since 2009, foreign exchange market strategists in the City of London speculate that the euro/sterling cross rate could depreciate from its current 0.9206 to parity. The reasons for sterling plunge against the euro since its 0.70 pence pre-Brexit levels are entirely rational. One, European growth rates have risen since last autumn while the UK economic data has been mediocre amid fears of a high street spending malaise due to the rise in food/petrol inflation relative to wages. Two, UK political risk has increased since Mrs May’s decision to call a general election to increase her parliamentary majority backfired with a vengeance. It is no coincidence that sterling peaked against the euro in April at 0.83 pence, when the City consensus was that the Tories would win a 100 seat majority in the House of Commons. Euro/sterling’s rise has only accelerated since the June general election. Three, Trump’s policy zigzags and legislative failures have caused global central banks to increase their accumulation of euros in their official reserves, another factor that boosts euro/sterling. Four, the post Article 50 Brexit negotiations clearly demonstrate that the balance of power lies with Brussels, not Whitehall.