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The Pound has been one of the best performing G-10 currencies recently. I believe the outperformance is here to stay and the underlining drivers of it are still firmly in place. The U.K. economy continues to improve: the recovery is strengthening, broadening and deepening and we expect that to continue to move the Bank of England closer towards the exit of monetary stimulus. Citi is more constructive on the U.K. growth outlook from here and expects the BoE to start hiking rate earlier than currently anticipated by the market. We think that as market expectations converge to this view, it should continuously add to the rate advantage of the Pound across the board and to underturn its performance from here.
What to your mind will be the major headwind for the British Pound throughout the year of 2014?
In terms of risks there are several bigger headwinds. The main event would be the Scottish independence referendum on September 18th. At the moment the market is clearly ignoring that for various reasons, one of it is that, according to the latest poll – the idea of the independent Scotland is still to gain traction with the voters. Hence, the "no vote" (the vote against independence) is still expected to be the winning one, which is not considered as a real threat for the situation. Having said that, we are seeing clients trying to bet on more volatility around those dates in case any aspect of this event could, in fact, produce some of that anticipated volatility. Needless to say, a positive vote (not our central case, but a risk) supportive for Scottish independence could be seen as negative for the Pound. The second, more fundamental risk, which is likely to stay with us for a while is the wide current account deficit of the U.K. economy. Indeed, we expect that the Bank of England may refocus its attention back to rebalancing the economy. However, in this case it is a clear question of timing, when exactly the situation with the still considerable sizable external balances of the U.K. economy will become an issue. We suspect that this could come, if there are more indications that the U.K. economy will rally in various asset classes, starting to show signs of overheating, which also could be signs of a bubble. Moreover, accompanying that if we witness signs that the leverage in the household system is starting to pick up a bit too much for comfort, it will be about time for the BoE to start refocusing again on rebalancing. Among other things it means growth on the back of exports, and in this regards somewhat weaker Sterling could be instrumental. In my opinion, in terms of timing that risk could materialize as we move closer towards the end of the year.
What are your forecasts for the GBP/USD and the EUR/GBP currency pairs for the end of Q2 and the end of 2014?
For the near term, we think that the Pound will be supported against both the Euro and the greenback. In case of the EUR/GBP, we anticipate that 0.81 or even 0.80 cents per Sterling could be useful targets to expect more downside data, partly because of the further hawkishness by the BoE. Also, due to the anticipations of the ECB to introduce more aggressive easing measures before the rate cuts and negative deposit rates in June, and possibility of QE in Q4 of this year should weigh on the Euro across the board. By implication, it also means that the move in the EUR/GBP will persist beyond the second quarter, whereas we expect it to depreciate somewhat reaching 0.79 by the end of 2014. Talking about the greenback the picture is slightly different, we expect a more upside movement from the Pound in the more near-term. In the Q2 we could be dealing with a renewed test of the previous multi-year high of 1.7043 or even higher, our target is 1.71. Over the long term the main drivers could be cable's negative fundamentals and the move by the Fed towards the QE exit with the fact that markets will start pricing in rate hikes, should ultimately play out in favor of the USD. This should limit the upside for the cable, so effectively, we anticipate that move to lose momentum, which could keep the Cable closer to current levels over a period of 6-12 months.