The slump in the value of the pound (GBP) against major currencies such as the US dollar (USD) and the euro (EUR) since the UK’s vote for Brexit on June 23 is not yet over, but 2017 will see sterling recover some ground forecasts UBS.
The pound began this week by slipping below €1.10, a six-year low against the single currency and at less than US$1.21 was at levels against the USD last seen in 1985. However in a memo circulated on Monday, UBS economist Dean Turner argued that having dropped by 20% in less than four months since the decision to exit the European Union (EU), GBP will eventually regain favour with investors.
The UBS prediction is more upbeat than that issued by some other banks. HSBC has forecast GBP parity with EUR by 2017 and Deutsche Bank expects GBP to have slipped further to below US$1.15 before the end of this year.
Turner and his team agree that “the pound’s joyride is probably not over as traders react to every twist and turn of the Brexit debate,” but expect the currency to “stabilise and recover over the next six to 12 months,” and predict that GBP will be trading at around US$1.36 in 12 months’ time. This compares with a pre-Brexit average of US$1.43 in the first half of 2016.
The memo cites four main reasons for anticipating a recovery by the currency:
- Markets have overreacted: UBS argues that the markets seem to be pricing for a “very hard Brexit” and a sharp deterioration in the UK economy, but sees both outcomes as unlikely.
“Both sides can be expected to make uncompromising demands that are initially poles apart,” notes the memo. “As the talks proceed, compromises will be made as they always are. Economic common sense should prevail. Among the items at stake are some £222bn of goods and services that the UK exports to the EU and approximately £290bn worth imported by the UK from the continent.
“To be sure, the UK is unlikely to go on enjoying the same level of free trade it has with the EU today, but both sides have the scope and incentive to compromise in their mutual self-interest.”
- A cheap pound will stop traders from shorting it: UBS believes that GBP is now undervalued. While that discount is unlikely to end in the near term, investors at current levels will start thinking twice before they taking out a new short position on sterling.
- UK assets and bonds look attractive to international markets: The cheaper pound makes UK assets such as property, companies and bonds are becoming more affordable to international investors. A pick-up in demand will, in turn, support the currency.
- A weaker currency will shrink the UK’s current account deficit: Sterling’s sharp fall is likely to reduce the UK’s trade gap, which has been running at a near record level. A reduced deficit should remove another reason for investors to sell the currency.
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