GBP: Relief rally? - Rabobank

Jane Foley, Research Analyst at Rabobank, notes that the GBP has made an impressive recovery vs. the EUR since early April, with the most recent gains finding incentive from the results of the UK opinion polls regarding the June 23 EU referendum.

Key Quotes

“Over the past couple of weeks opinion polls have been suggesting that the ‘Remain’ is extending its lead and that political uncertainty is thus subsiding.

The recent gains in the pound clearly limits the scope of a relief rally on a ‘Remain’ vote next month. That said, a clear victory for the ‘Remain’ vote is still likely to trigger a strong bout of GBP buying. By contrast a close vote is likely to be greeted with a more cautious reaction since it may signal that pressure for another vote in the next ten or so years could re-surface.

It may also leave open the risk that another European country could hold a referendum on EU membership over the next couple of years. This is a risk which could be detrimental to the outlook for the EUR over the medium-term. For GBP, a Remain vote on June 23, is likely to see focus quickly return to UK economic variables.

According to the minutes of the BoE’s April MPC meeting “some lenders had reported that, notwithstanding still-favourable credit availability, the demand for finance from some large companies had dipped somewhat, partly reflecting EU referendum uncertainty.

These developments highlighted the risk that the economy could slow somewhat in Q2.” While there is some evidence to suggest that Brexit uncertainty has had some economic impact, the UK has also been experiencing many other headwinds. These include the legacy impact of last year’s sterling strength, weak US growth in Q1, slowing growth in emerging markets and weak levels of demand in the Eurozone.

Assuming there is a Remain vote, we are forecasting that the BoE will hold policy steady at least until May 2017. At the end of last year we were more optimistic on the UK economic outlook and saw scope for a moderately earlier tightening in policy from the BoE. The slackening in growth suggests that even on a Remain vote next month, it is unlikely that EUR/GBP will find the incentive to return to its November lows in the region of 0.70.

Since GBP has started to price in a ‘Remain’ outcome to the Brexit referendum, a shock of any ‘Leave’ vote would hit hard. We would expect EUR/GBP to spike higher towards the 0.86 level and that cable could plunge to GBP/USD1.26. Since the greatest legacy of a Brexit could be its effect in opening up nationalistic tendencies in the Eurozone we would expect EUR/USD to drop towards 1.08 on a Brexit in reflection of political uncertainty in Europe.”