GBP: Structural should outweigh the cyclical and it should fall further - HSBC

According to analysts at HSBC, it should be the spring of hope in UK for those who voted to leave the EU as not only are they expecting to take back control politically, but on top of this, growth has been resilient, inflation is picking up and there are signs that GBP is stabilising.

Key Quotes

“For the Remainers, despite the warmer weather, it looks increasingly like the winter of despair. In their eyes, the UK is moving closer to a hard Brexit. From this vantage point, inflation is driven by a lower GBP and higher import costs, real incomes are squeezed and the current account deficit remains wide.”

“This split has also been prevalent in financial markets. What should the market believe? The cyclical data, representing the best of times, which has held up well and makes GBP look undervalued; or the structural data, which shows the worst of times and tells us the currency still has further to fall.”

“For the last 25 years, the correct way to think about GBP was cyclically. In this mindset, inflation is driven by higher growth, so the market is right to expect tighter monetary policy. But just as with politics, we have entered a new era for GBP. Now, inflation is being driven by a weaker currency which has fallen because of the large current account deficit and political worries. This has led to a pick-up in imported inflation, causing a squeeze in real incomes, as wages struggle to keep up with prices. This should limit growth and leave the BOE less likely to hike.”

“GBP is driving inflation; inflation should not be driving GBP. The drivers are structural not cyclical. As such, the reaction function of GBP should be different.”

“While the markets are looking at the cyclical data and seeing the Light, we would argue for watching the structural data, which is still plunged in Darkness. The recent trade numbers do not yet show a clear sign of rebalancing. Until they do, we would look to sell the currency on the back of stronger cyclical data. We see GBP-USD falling to 1.10 by the end of 2017 and EUR-GBP rallying to parity.”