GBP is trading on a political and structural basis - HSBC

David Bloom, Strategist at HSBC, suggests that GBP used to be a relatively simple currency that used to trade on cyclical events and data, but now it has become a political and structural currency.

Key Quotes

“This is a recipe for weakness given its twin deficits. The currency is now the de facto official opposition to the government’s policies.

The question we have asked hundreds of investors throughout the world is do you want to buy a currency that has massive twin deficits with an unknown political direction and for that risk you can get zero rates? In other words we should have some kind of risk premium which through QE is not showing up in bond markets. It’s the currency that needs to offer this risk premium.

To us the FX market is exhibiting an uncanny resemblance to the five stages of grief. First, following the Brexit vote came the denial – theories circulated whether a second referendum would have to take place. Second was anger – claims the vote was unfair. Third was the bargaining – arguments maybe it wouldn’t be that bad, what if the UK followed the Norwegian or Switzerland model. Now the fourth a gloom is prevailing over GBP.

It’s become an uncomfortable reality to the market - post the conservative conference – that the UK will embark on a ‘hard Brexit’. A charm offensive by the Chancellor to try and address these concerns was met by a veritable plunge in the currency, especially after he hinted that he would need to vet any future QE. Suggestions from the UK’s minister for International Trade even suggested the UK should not enter a customs union, the implications being a messy combination of tariffs on goods and a harder challenge in replacing the EU ‘passport’. Further uncertainty prevailed following media reports discussing that Carney may not take a second term.

Add to that, comments from Eurozone leaders and the picture becomes more complete. Brexit, whether one likes it or not, is a political decision, one we have to respect. However, the argument which is still presented to us - that the UK and EU will resolve their difference and come to an amicable deal – appears a little surreal. It is becoming clear that many European countries will come to the negotiation table looking for political damage limitation rather than economic damage limitation. A lose-lose situation is the inevitable outcome.

GBP has gone from a cyclical to a political and structural currency. The structure and politics are conducive to a currency that needs to fall to a level that causes balance. That balancing act is and has been in our eyes is still a lot lower than where it is today. We continue to look for GBP-USD at 1.20 by year end and 1.10 by end 2017, taking EUR-GBP to parity.”