“We haven’t had many opportunities to praise the performance of the British Pound over the past 5 years, but you can’t fault its efforts at the start of 2021.” – Kamal Sharma, BofA.
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The British pound rose in a straight line in the first quarter of 2021 to hit buffers in the second quarter, where will the second half of the year take the UK currency?
Analysts Bank of America published their mid-year bulletin on the pound sterling and they say the sterling’s outperformance in 2021 is not over yet, especially now that it no longer looks overbought.
“We haven’t had many opportunities to praise the performance of the pound sterling over the past 5 years, but we can’t fault its efforts at the start of 2021,” said Kamal Sharma, FX strategist at Bank of America.
In a new research note, Sharma points out that when her team looked at the currency at the end of a stellar first quarter, she warned that the second quarter would not be so easy for bulls.
This call was found to be correct given the sideways grind seen in the trade-weighted pound. It is the price action that is particularly evident in the pound to euro exchange rate which appears to have peaked at the moment.
Above: the performance of the trade-weighted pound. This is a general measure of the performance of the British Pound based on the most important exchange rates of the British Pound.
The pound-dollar exchange rate looks decidedly bearish at the start of the second half of the year, having fallen below 1.40 and now trading at 1.3750.
âRisks around the pound sterling were likely to be more symmetrical for the rest of the year than they were in the first quarter,â Sharma points out.
But regarding the outlook, Sharma says that “our bias remains for further cyclical outperformance until the end of 2022”.
There are three positive cyclical and growth tailwinds that Sharma expects to help the pound: the global liquidity glut; a much inferior FX flight environment; and the hawkish backbone of the Bank of England.
“Our reservations at the start of the year that Brexit would be a more widespread short-term concern for the pound were clearly unwarranted and not only has the pound successfully re-coupled with the rest of the G10 high beta complex FX, the biggest upside surprises so far this year has been the successful rollout of vaccination in the UK, followed by the hawkish backbone of the Bank of England, effectively dropping the negative rate debate, â Sharma said.
The Bank of England now looks set to hike interest rates in 2022, ahead of much of the G10 group.
This pioneering status could benefit the pound sterling.
Above: The performance of the British pound over the past month
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However, as reported in recent days, expectations for this first rate hike have not really changed with the Bank’s policy report in June and a subsequent speech by Governor Andrew Bailey suggesting there would be no rush. to increase rates.
As one analyst recently noted, for the pound to continue to rise, expected data for the first rate hike must continue to be released, and there is no indication that this can be sustained.
For now, therefore, the Bank of England is in the price of the pound and could stall until a new impetus arrives.
Bank of America nevertheless wishes to point out that the Bank of England is ultimately the one that has reached a âhawkishâ pivot by pointing to an interest rate hike in 2022.
“The Bank of England appears to be at the forefront of the debate over broader policy normalization, including quantitative tightening. Although forward guidance has been diluted, the BoE has indicated its tolerance for a breach of inflation is limited, âSharma said.
So while the Bank might not be a source of gains just yet, it is nonetheless supportive and this could support the Pound and protect it against a significant drop.
Positioning is seen as a potential headwind by Bank of America: British Pound was a hot choice among economists and strategists at the start of 2021 and it still risked creating congested trade.
This congestion became increasingly evident towards the end of the third quarter, with positioning data suggesting the currency was becoming overbought.
The remaining part of that positioning at this stage will be important in determining whether a rebound can take shape.
“The momentum and positioning indicators have moved away from their respective overbought signals, which we believe should allow the pound sterling to advance in the coming quarters,” said Sharma.
Sharma took into account the body of evidence available from the various research departments of Bank of America and concluded that “the context remains favorable for a further outperformance of the pound for the remainder of the year”.
But the pound sterling is likely outperforming the highest against low-beta currencies, which include the yen and the Swiss franc – two currencies with ultra-low interest rates.
Gain expectations are partly based on Bank of America’s observation that a good chunk of global investors remain of the view that UK stocks are undervalued, suggesting the potential for UK markets to catch up.
Foreign buying of UK government bonds and M&A activity are also expected to support sterling overall in the coming months.
“The UK continues to be the largest net beneficiary of cross-border mergers and acquisitions in Europe, while the latest M4 data shows another strong impression for overseas purchases of UK gilts – building eight out of 10 months,” Sharma said.