GBP: Downside potential? - Rabobank

Jane Foley, Research Analyst at Rabobank, suggests that the growth in the UK economy in the current quarter is slowing – that is the clear impression given by recent UK economic releases.

Key Quotes

“The release of the BoE Quarterly Inflation Report should shine light on how the Bank is viewing the softness of economic data. There have been plenty of reports suggesting that Brexit uncertainty is the cause of many of the misses in recent UK economic data. Even Chancellor Osborne has added his voice stating that ‘there are warnings . . . that the threat of leaving the EU is weighing on our economy. Investments and building are being delayed”.

While there does appear to be tangible evidence that uncertainty is weighing on activity in areas such as commercial property deals, at this juncture it is impossible to distinguish whether Brexit uncertainty is mostly responsible for the disappointing tone of UK economic data or whether this is indeed a product of external risks and the sluggish pace of global growth. One challenge for the Bank next week will be to explain its growth predictions while stepping around the sensitivities of the Brexit campaign.

The timing of the June 23 referendum will clearly pose some difficulties for Bank staff in deciding on their economic projections for the next year or so. It is likely that on a Remain vote sterling will see a relief rally and that business confidence will also push higher.

The sterling effective exchange rate pushed higher through most of April. Some of the better tone had been linked with the publication of the Treasury’s document in favour of a Remain vote and the coincident endorsement of President Obama for EU membership. Around this time opinion polls started to indicate a better showing for the ‘Remain’ vote. Currently, however, opinion polls are suggesting that the ‘remain; and ‘leave’ campaigns are again neck and neck. In view of the concern that election complacency is higher amongst remain voters, the chances that the UK economic is facing considerable economic and political uncertainty remains very high. Consequently we see risk of downside pressure for sterling in the coming weeks.

Although a weaker pound may increase the risks of imported inflation we do not associate this will a more hawkish outlook for BoE policy since imported inflation acts in the same way as a tax hike. With slower growth risks likely to guide the MPC towards a later lift off for tightening. the likelihood is that even a relief rally for GBP on a remain vote will be capped. On a ‘remain’ vote we expect EUR/GBP at 0.75 on a 3 mth view significantly above its Nov lows.”