UK: The near-term path for the British Pound – Goldman Sachs

Research Team at Goldman Sachs, suggests that they have been thinking about the near-term path for the British Pound in terms of two things, first, there is the question where GBP/$ would trade in the event of “hard Brexit” and second, there is the question what probability to assign to “hard Brexit”.

Key Quotes

“High Court decision is a move back in the opposite direction. It reduces the odds that Article 50 will be triggered by March and, more fundamentally, may limit how aggressive the government can be in its negotiating position. The probability of “hard Brexit” has shrunk, which could see GBP/$ settle around 1.26 in the near term, a half-way house between pre-conservative party conference levels (1.30) and the aftermath of the flash crash (1.22). Big picture, our conviction is that Sterling needs to weaken more, given that the trade-weighted decline is only 14 percent so far, well shy of our 20-40 percent range.

Prime Minister May committed herself to triggering Article 50 by March, which – together with accompanying populist rhetoric – raised the probability of “hard Brexit.” At the time, our impression was that the market was slow to price this rising probability and we reiterated our year-end target for GBP/$ on Oct. 6, the morning before the flash crash. Recent High Court decision is a step in the opposite direction, since – at the very least – it injects uncertainty over the government being able to trigger Article 50 by March and, more fundamentally, may constrain just how aggressive the negotiating position with the EU can be. If 1.30 was the pre-conservative party equilibrium for GBP/$ and 1.22 was where GBP/$ settled once the market had updated its odds for “hard Brexit”, we think GBP/$ could now settle around 1.26, a half-way point of sorts in the near term. Our conviction is that the fall-out from Brexit will be large and we maintain our year-end target for GBP/$ of 1.20.

Our conviction to maintain our near-term forecast for Sterling weakness rests on the fact that the fall in the currency is still relatively modest in trade-weighted terms. On our estimates, the Pound has fallen 14 percent from pre-Brexit vote levels, which is still well short of the upper bound of our range between 20-40 percent that we derive using various approaches. We continue to think that – even with the decline since June – the Pound is not yet cheap and that more declines are coming.”