Reports published by JPMorgan and BNP Paribas late last month offered differing assessments of sterling’s prospects in the second quarter of 2021.
The former suggested GBP’s resilience was wearing thin as the worsening Covid-19 situation in Europe threatened economic spillover – and that the prospect of another Scottish independence referendum was a reminder that the economic and political fallout from Brexit was far from over.
The JPMorgan analysts warned the market was in danger of assuming away the long-term drags to UK growth from what was a narrow trade deal with the European Union.
In contrast, BNP Paribas’s second-quarter global outlook referred to scope for further appreciation, describing UK equities as cheap and suggesting the market had more room to price in central bank policy tightening than anywhere else in the G10.
“In addition, aside from global issues around vaccine efficacy, idiosyncratic risks do not pose a significant threat to GBP in the near term in our view,” says Parisha Saimbi, G10 FX sterling strategist at BNP Paribas Markets 360.
The bank expects EUR/GBP to fall to 0.84 by the end of this year and to 0.83 by the end of 2022, and for GBP/USD to rise to 1.46 by the end of 2021.
NatWest Markets also sees further gains for sterling versus the USD and EUR over the coming quarter as relative growth expectations shift further in favour of the currency, in particular the easing of Covid-19 lockdown restrictions.
“While such a story is now better understood by financial markets and therefore more fully priced in, we suspect rebalancing of international portfolios in favour of the UK has further to run,” says Paul Robson, the bank’s head of G10 currency strategy.
“The small window for sterling gains appears to have become larger in recent weeks given Europe’s third Covid-19 wave.”
Deutsche Bank is slightly more cautious, taking a neutral stance on GBP in the short term and forecasting GBP/USD at 1.45 by the end of the year. It sees the risks around Bank of England (BoE) pricing as being more balanced at current levels, explains Shreyas Gopal, strategist at Deutsche Bank Research.
“The market has priced in close to 20 basis points of hikes for the next two years, but our view is that it is more likely rates will remain on hold,” he says.
“While growth is set to outperform the Bank of England’s forecasts for 2021, the bar for inflation to stay above target throughout the first half of next year is high.”
There must be some concern that the more the global economy reopens, the more apparent the drag from Brexit will be
Kit Juckes, Societe Generale
The pound has gained around 3% against the euro this year, reaching its highest level for more than 12 months. Indeed, it is one of only four currencies – the others being the oil-sensitive NOK and CAD, and the South African rand – to outperform both the US dollar and the euro in 2021.
There is a lot of good news factored into the price, according to Kit Juckes, chief global foreign exchange strategist at Societe Generale.
“There must be some concern that the more the global economy reopens, the more apparent the drag from Brexit will be,” he says.
Geoff Yu, senior EMEA market strategist at BNY Mellon, points out that recent BoE commentary has been rather mixed, with the monetary policy committee’s unanimous decision to maintain bank rate at 0.1% at odds with its chief economist Andy Haldane’s reference to the potential for a “rip roaring” recovery.
NatWest Markets sees scope for markets to price an earlier and quicker turn in BoE pricing, something that can support sterling further, suggests Robson.
“For example, a taper is possible at the May monetary policy committee meeting,” he says. “This is likely to come as it becomes apparent that household savings are being rundown more quickly than assumed in Bank of England projections.”
On UK equities, BNY Mellon’s Yu notes that while the FTSE 250 is trading well above its 2017-2019 average, the FTSE 100 is looking far more undervalued.
“It appears that the bulk of the flow is attempting to capture the UK reopening, whereas the FTSE 100 – with much greater global exposure – is expected to remain under the weather for some time,” he adds.
BNP Paribas thinks UK equities are at the sweet spot for 2021 as they benefit from the highest value factor exposure across key global indices, namely an attractive valuation compared with their European and global peers, a rapid and robust vaccination roll-out, and abundant fiscal and monetary policy support.
What about Scotland?
The potential elephant in the room is Scottish independence.
The outcome of next month’s Scottish parliamentary elections will be scrutinized, as notable gains for the pro-independence parties would undoubtedly lead to even stronger calls for another referendum than was the case after the result of the referendum on the UK’s membership of the EU.
BNP Paribas’s Saimbi acknowledges that UK risk premia could begin to rise in the lead up to the elections and after, especially if the Scottish National Party (SNP) wins by a landslide.
“That said, with the path to referendum approval likely to be bumpy and lengthy, we would expect any initial market move to be limited until approval is granted,” she says.
Deutsche Bank reckons a second independence referendum is unlikely to take place before 2023, which means the market’s focus on this issue in the second half of this year is likely to be limited.
Juckes at Societe Generale even suggests that Scottish independence would not be particularly bad for the pound.
“It would have been when the income from North Sea oil was much higher, but that has changed and Scotland has an older population and is a net beneficiary of fiscal transfers,” he concludes.
