GBP: A different sort of normal - SocGen

According to Kit Juckes, Research Analyst at Societe Generale, the fact that sterling is now already 8% below the average of the 10 years before the Brexit referendum is its greatest source of support in the absence of any optimism about the economic outlook.

Key Quotes

“By the same token, if the UK’s ‘new normal’ is a trend growth rate that is below 1.5% per annum, and if exports, particularly of services, are hampered by Brexit (a reasonable view), then the post-Brexit average level of sterling, at least in real terms, may not be much above current levels.” 

“But in that simple statement lies the risk to the outlook for sterling. There is a high probability that sterling will bump along in a lower range for the next few years. But there’s a small chance that Brexit isn’t as bad as we fear. Perhaps there will be a miraculous recovery in productivity back to 1% or more per annum. Perhaps the UK will develop new trading relationships quickly. Or, perhaps less unlikely than the two other possibilities, there won’t be a ‘hard Brexit’ after all. If the UK stays in the EU, or stays in the Single Market, it would be positive for UK and EU growth, regardless of whether or not it would be good for the harmony of the UK people. To be clear, we don’t think this is likely, but nor is it completely impossible, and a glance at what the GBP REER was doing in 2012-16 ahead of the referendum gives a clue about what might happen if the political landscape changes.” 

“On the grounds that the UK not leaving the EU would be good for the EU, and probably for the euro as a result, the bigger move would be in GBP/USD, rather than EUR/GBP. Add in the fact that sterling’s valuation (FEER or PPP) looks more stretched against the dollar than the euro, and the more prosaic consideration that our year-end EUR/USDD forecast is 1.27, what this amounts to is a very big upward skew in the range of outcomes we can imagine for GBP/USD. We see about a 15% chance that GBP/USD will be above 1.50 at end-2018. That compares with an estimated 5% chance that GBP/USD will be below 1.20.”