GBP/USD to Fall Back to 1.20 by the End of 2017: HSBC

The Pound is to remain weak during 2017 due to ‘imbalances’ in the economy and political instability says HSBC’s David Bloom.

Despite upgrading their forecast for GBP/USD from 1.10 to 1.20 in light of certain economic improvements and a weakening Dollar, HSBC remain sceptical about GBP.

The UK’s large Current Account deficit is a major imbalance which analysts think will weigh on the Pound.

The Current Account measures the aggregate flow of money in and out of a country, if it is in deficit it means a higher demand for foreign currencies than for the Pound, which must then fall for the market to regain equilibrium.

Although the Pound already fell considerably following the referendum and this has increased UK exports and narrowed the Current Account deficit from 5% of GDP to 2.5% in Q4 2016, it is still sizeable enough to warrant a negative outlook for GBP.

“The Q4 2016 deficit was only 2.5% of GDP – a lot narrower than we had expected and a significant improvement from prior quarters. The jury is still out on how sustained this will be. After all, the trade balance data so far in Q1 does not show a significant narrowing in the goods deficit. But the overall move in the current account certainly appears to be in the right direction,” says Bloom in a note dated April 24.

The updated forecast on GBP/USD comes as HSBC are seen slashing their US Dollar forecasts.

The Dollar's profile was lowered against Sterling, the Euro and Yen after analysts came to the conclusion that President Donald Trump's proposed economic policy changes are not going to deliver the fuel required to keep the Dollar rally burning.

This has allowed HSBC to row back on what were rather quite pessimistic expectations for GBP/USD.

Brexit Risks and The June Election

The other main factor is political uncertainty in relation to Brexit.

“There is plenty of political uncertainty, particularly with a snap general election to be held on 8 June and ahead of Brexit negotiations with the EU. GBP will still face periods of downward pressure,” says Bloom.

The current thinking on the FX implications of the election is that a Conservative win will be positive for the Pound, because it will enable Theresa May to be more flexible in her negotiations with the EU.

Currently, May only has a small majority of 16 MP’s and this makes her vulnerable to the wishes of a small clique of hardline Eurosceptics within her own party who could force her to take a harder line in Brexit negotiations.  

If she increases her majority to over 50, however, it would mean she would not have to take into consideration the hardline Brexiters and could forge a ‘softer’ deal with the EU.

Yet some are sceptical - not just about whether she can get a better deal by increasing her majority but also about her motives in calling a snap general election.

The EU’s senior Brexit coordinator Guy Verhofstadt does not think the UK will get a better deal if May increases her majority.

“The theory espoused by some, that Theresa May is calling a general election on Brexit in order to secure a better deal with the EU, is nonsensical,” says Verhofstadt, writing in the Observer.

“We can only conclude that many British politicians and the media still don’t fathom how article 50 will work in practice. Will the election of more Tory MPs give Theresa May a greater chance of securing a better Brexit deal? For those sitting around the table in Brussels, this is an irrelevance,” he added.

If Theresa May is hoping for a ‘transitional deal’ to cover the UK during the Brexit negotiations, she may be in for a disappointment, as any such deal will require the unanimous agreement of all 27 of the members of the EU.

“Unless the UK government requests transitional arrangements to the contrary, and these requests are agreed by all EU countries, UK citizens will have no more of a right to holiday, travel and study in EU countries than tourists from Moscow or students from Mumbai,” said Verhofstadt.

A further blow to the UK could be the increased likelihood that Emmanuelle Macron will be made the next President of France as he is a well-known critic of Brexit.

“The Pound’s euphoric rally on last week's snap election news could be at further risk if the market loses confidence in the election's ability to make for easier negotiations with the EU. The probability of Macron as the next President in France is also not doing any favors for the Pound, with the candidate a well-known critic of the UK leaving the EU,” said analysts at LMAX Exchange.

In the short-term they note the 1.2775 as a key level, which must hold for the Pound’s bullish outlook to remain valid.