Pound to Dollar Rate Forecast to Bounce Back to 1.50 on Remain Vote

Pound to dollar exchange rate

The British pound to dollar exchange rate remains at lofty valuations when we consider the risks to sterling that lie ahead argue analysts at ING in a new client note.

Analysis from Dutch lender ING reckons markets have been far too kind to the British pound and have failed to fully price into the currency the full extent of the risks pertaining to the EU referendum.

As such, the GBP/USD is looking potentially overpriced.

“In our opinion not enough Brexit risk premium is priced into GBP. We see just 2% risk priced into GBP/USD. The rest of G10 and EM FX have so far been insulated,” says Petr Krpata, Chief EMEA FX and IR Strategist with ING in London.

This is important for two reasons:

1) We could be about to see some heavy falls if over coming days if markets wake up to this and believe sterling is too richly priced
2) Should the UK vote to Remain in the European Union, as widely expected (odds of an exit still reside around 30%), then the GBP/USD will not rally significantly.

There is a popular assumption at present that sterling will rally sharply in the event of a Remain vote. However, we have noted before that this is a view held by a number of analysts.

“While we are likely to see a recovery in GBP, we expect any relief rally to be limited and short-lived,” says Krpata.

Indeed, following the 2015 May General Election (where there was a similar 2% risk premium priced in ahead of the event), GBP’s relief rally lasted less than a week.

ING think that any material post-referendum GBP upside could be muted for two reasons:

1) Pre-referendum loss of UK economic momentum has been sizeable; it may take a bit longer for domestic data to get back up to speed.

Should the UK vote to remain in the EU, then ING would expect activity to bounce back.

However, there remains uncertainty as to whether the referendum is the only factor behind the slower activity. Furthermore, the slowdown has been much sharper than anticipated, any telling recovery may not be evident until the late 4Q16 data.

This suggests that the BoE will be in no rush to start normalising policy, this should weigh on the pound.

2) Given that not much Brexit risk premia is priced in, any material GBP relief rally following a vote to stay in the EU would be a positive risk overshoot

As noted in Part I, a less than adequate Brexit risk premium is priced into GBP spot markets and therefore any sizable relief rally (eg, greater than 2% for GBP/USD) would, in ING’s view, be an overshoot of fundamentals.

“The post-referendum global risk environment will play a key role and the risk-sensitive GBP would likely match any partial recovery in risk sentiment. Yet, we have noted that event-driven moves in equity markets have been fairly short-lived in 2016 (Figure 11). Hence, any GBP upside driven by a positive risk impulse may only prove to be a short-term effect,” says Krpara.

ING are also setting 1.50 as a post-referendum target:

GBP to USD exchange rate bounce

Analysts at Capital Economics agree with the assumption that sterling is unlikely to enjoy a massive rally against the dollar in the event of a Remain vote.

Analysts at Capital Economics say they expect a knee-jerk strengthening in financial markets following a Remain vote and Capital Economics see the prospect of GBP/USD racing to 1.50 in the event of a Remain vote winning.

“The UK’s relative rate expectations might also have been pulled down a bit by Brexit fears. But even accounting for that, we think that cable would only rise from its current level of $1.45 to about $1.50,” says Capital Economics' Roger Bootle.

GBP to USD Forecast Below 1.30 on Brexit

Markets continue to anticipate Remain winning the referendum with bookmakers continuing to attribute about a 70% chance that the UK will vote to Remain.

But, what will happen to sterling on a Brexit?

“Not enough Brexit risk premia is priced into GBP spot, meaning that the scope for a GBP/USD decline is meaningful should the UK vote to leave the EU,” says Krpata.

This should be the case even if EUR/USD does not fall meaningfully, which ING believe will be the case.

In the remote case of the severe EMU crisis on the back of a Brexit ING suggest a panic EUR/USD fall would likely outweigh relative safe haven GBP strength against EUR (as in the these circumstances the UK leaving the EU would no longer matter so much) – hence cable would still fall.

GBP/USD is therefore likely to fall below 1.30 on Brexit say ING.

GBP/USD's Medium-Term Uptrend Eroded

Looking at the short-term trading timeframes the uptrend that has been in place over the past four weeks or so appears to have been negated by the falls we have witnessed over recent days.

"GBP/USD sold off last week and has now eroded the 4 month uptrend at 1.4304. The close below here should cause the chart picture to deteriorate," says Karen Jones, a technical analyst with Commerzbank.

Jones says initial support line lies 1.4083/05 area where the January and April lows were made and these guard the 1.3837 February low.