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The pound may have sold off into the Bank of England (BoE) meeting, but its recent drop is bringing back the bulls.
Sterling slid almost 6% in the three weeks leading up to the May BoE policy announcement, as traders slashed bets on a hike in borrowing costs.
Now they’ve been proven right as the central bank opted to stay on hold, banks including NatWest Markets and Nomura International see value in buying up the UK currency at these levels.
“The resetting of BoE policy expectations provides an attractive risk-reward balance in favor of entering strategic long pound-dollar exposure,” wrote NatWest Markets strategists including Paul Robson in a note.
“We target a move to $1.50 in one year,” he said, up from around $1.35 currently.
NatWest sees the UK currency benefiting from the mispricing of UK political and Brexit risk, stretched long-term valuations and the likelihood of a weaker dollar over the medium-term.
Nomura analyst Jordan Rochester also expects a “slow drift higher” in cable on dollar weakness. A falling greenback saw the pound edge up 0.3% to $1.3588 by 11:30 on Monday.
Money-market pricing shows investors now see an 85% chance the central bank will increase borrowing costs in November, while a rate hike is fully priced in by February 2019. This means pound watchers will be closely eyeing economic data for signs that the BoE was right to put first-quarter economic weakness down to bad weather.
Tuesday’s labour-market data will be the next indicator of second-quarter economic health, with jobless claims for April to be released alongside earnings for March. Signs of wage growth should boost the pound and support expectations for a rate hike at upcoming BOE meetings, according to Credit Agricole SA analyst Manuel Oliveri.
Customs debate
A return to focus on the fundamentals does present risks for the UK currency. The Citi Economic Surprise Index remains close to the lowest since July 2012, with data consistently surprising to the downside.
It was this that led the BoE to vote 7-2 to keep rates on hold last Thursday, with Governor Mark Carney making clear that future moves are dependent on an economic recovery.
Traders will also be watching out for any update on the government’s stance toward customs union arrangements. After canceling a meeting of the Brexit ‘war cabinet’ on May 10, Prime Minister Theresa May issued a plea for unity in the Sunday Times, calling on Brexiteers to “trust me to deliver.”
“In the long-run for the gains we expect, we need the data to prove us right and for the customs union issue to be resolved,” said Nomura’s Rochester. “I expect the Brexiteers to lose the argument.”
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