While the Brexit vote was a shock (we attached a 40/45% probability), we are not surprised by the initial currency market reaction. Cable still remains within our forecasted one-month range between 1.3000 and 1.5000.
In our previous base case scenario assuming that the UK voted to remain within the EU we were expecting cable to stabilise in the year ahead at around the 1.5000-level. However, the initial sharp pound weakness following the Brexit vote is fundamentally justified and is not overshooting in the near-term. The heightened political uncertainty in the UK including today’s resignation from Prime Minister Cameron with a new Conservative leader to be elected in early October, will continue to weigh heavily on the pound. The increased risk of recession in the UK and looser BoE policy in the year ahead justify a weaker pound. Capital inflows into the UK will also be dampened making it more challenging to the finance the UK’s elevated current account deficit requiring a weaker pound.
In these circumstances, we expect cable to fall into the mid-1.2000’s in the second half of this year before rebounding modestly back above the 1.3000- level in 2017 as heightened uncertainty gradually eases. The pound is already significantly weak according to our long-term valuation models which should help to dampen further downside unless there is a run on the pound.
We expect further more modest upside for EUR/GBP as well rising towards the mid to high 0.8000’s in the second half of this year before falling back towards the 0.8000-level in 2017. It is consistent with our alternative Brexit scenario outlined prior to the release of the referendum results.
Copyright © 2016 BTMU, eFXnews™Original Article
