GBP has room for further upside - ING

The agreement of a Brexit transition deal yesterday was a genuine positive surprise for GBP markets – not least as investors had broadly scaled back their expectations of any progress being achieved as early as this week, according to Viraj Patel, Research Analyst at ING.

Key Quotes

“While we do believe that it is the second-round effects of an agreed transition deal that will determine the future path of UK asset prices and GBP, it is worth pointing out two key learning points for investors when it comes to pricing in short-term risks around Brexit: (1) despite all the huffing and puffing in the run-up to crunch talks, it is clear that both UK and EU officials are implicitly pursuing an economically rational Brexit – one that looks to safeguard their respective domestic economies ahead of any political agenda (we note both parties have ended up compromising on previously stipulated red lines in the divorce and transition deals); and (2) given the complexities of Brexit, GBP markets remain structurally pessimistic over future progress and the currency is bearing the brunt of political uncertainty – which lends itself to asymmetric risks (greater upside in the event of a positive outcome, limited downside bar the absence of a complete breakdown in UK-EU talks).”

“Both points mean that an undervalued GBP will continue to be the ‘comeback kid’ in FX markets in 2018 – with a natural tendency to drift higher (we still look for a 3-5% sterling appreciation in trade-weighted terms this year). In the near-term, look for GBP’s focus to shift back to UK economic fundamentals. A Brexit transition deal is one element of GBP’s bullish trifecta this week; if all the cards were to fall perfectly into place – and we also see a status quo hawkish Bank of England policy message and constructive UK inflation data – then we wouldn’t rule out a further move up in GBP/USD towards the year-to-date highs around 1.4250-1.4300. Today’s UK CPI data is set to show inflation remaining sticky above-target – which supports the BoE’s renewed inflation concerns and the case for a near-term rate hike.”

“Indeed, with the UK economy at an inflection point – in theory, reduced Brexit uncertainty means the scope for a recovery in UK economic activity over the coming year has increased (upside growth risks allows the BoE to shift focus to inflation). We feel GBP markets are underestimating this channel – and therefore retain our conviction call for GBP/USD to move up to 1.45 in 2Q18.”