Thursday, 21 July 2016

Pound recovers to €1.20 vs Euro - what next for Sterling?

I'm back in action today after my break, and plenty has happened in the currency markets in the last few weeks. Sterling has strengthened against the Euro and other major currencies, due to Theresa May becoming our new Prime Minister, removing much of the political uncertainty that had put Sterling under pressure. The Bank of England also decided not to cut interest rates, which some had expected them to do. As the chart below shows, this caused GBP/EUR rates to rise from €1.17 to above €1.20 where it has since stabilised:


Political Stability helps the Pound


Before I jetted off to Menorca, it looked like the UK was in for a prolonged period of political uncertainty. The Conservative leadership race was underway, but when Andrea Leadsom pulled out of the race, it paved the way for Theresa May to become our Prime Minister. I think this is a good choice, and it also means we've avoided a lengthy 2 month leadership contest that would have been quite destabilising in what is a critical time following the vote to leave the EU. Markets hate any type of uncertainty, and this was one of the reasons the Pound was struggling.

I'm encouraged by our new Prime Minister and the markets certainly reacted positively, with the Pound rising when the news broke.

Interest Rates and the Bank of England


The other main reason for Sterling's rise is the fact the Bank of England last week chose to leave interest rates on hold at 0.5%. Many had expected them to cut rates by 0.25% and this had been partially priced into exchange rates. When they decided to leave things as they were, the Pound made some gains. I still think that the BoE will have to do something in the coming months, whether it's a cut to the base rate, or an increase to our QE stimulus programme. If either of these things happen in August, expect the Pound to fall.

What next for Sterling exchange rates?


Things are not as bleak as many had predicted in the immediate aftermath of the Brexit vote. The IMF have recently revised their gloomy predictions for economy growth, saying they expect the UK to grow at a faster rate than Germany and France. Once we leave the EU, we will also be free to make trade deals with other major economies, something the EU was unable to do. However, all of this is some way off, and while the immediate political uncertainty that was holding the Pound back has gone, we now face a prolonged period of economic uncertainty, and it's for this reason most major banks and analysts still expect the Pound to remain under pressure.

When the UK invokes article 50, probably early next year, the process of negotiation with the EU can start, and it will then take at least 2 years before everything is finalised. Until then, nobody knows what the future will hold, and this is likely to limit investment and confidence in the UK economy.

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