GBP: Feeling the pressure point
GBP is under immense pressure and GBP/USD reached the lowest level since 1985. The mix of external funding needs, still not stretched valuation and economic uncertainty is weighing on GBP in the strong USD environment. Unless markets calm down, GBP/USD 1.10 level can no longer be ruled out
GBP is under immense pressure and GBP/USD reached the lowest level since 1985. In our view, three factors are currently weighing on GBP:
The worst current account position among G10 FX bites
In the current dollar funding crunch, a currency of a country with an ongoing funding needs and the exposure to the banking sector is unlikely to do well. The UK current account deficit has been a long standing negative for GBP. Even the post-Brexit fundamental hit to the UK economy did not change the UK current account dynamics and the deficit has remained elevated. Within the entire G10 FX space, GBP ranks the worse when it comes to the current account situation. This is particularly the case when compared to its European peers, where all G10 currencies show a better current account positions than GBP (Figure 1).
Figure 1: GBP suffers from worst current account position in the G10 FX space
While the dollar suffers from the current account deficit too, unlike GBP, the dollar is a reserve currency of choice and during the periods of not-well-functioning markets, demand for the dollar is clear (as seen on the price action over the past days). With GBP not standing out as a currency with either high or low correlation with risk over the past months (as Figure 2 shows, it is close to zero and in the middle of the G10 FX spectrum), today's sell-off thus seems to have a lot to do with sterling idiosyncratic factors.
Figure 2: The usual GBP correlation with risk does not stand out
Despite the multi-year sell-off, GBP is not cheap
On the valuation side, we have been arguing for a long time that GBP fair value has experienced a structural decline since the Brexit referendum. For example, GBP fair value vs EUR declined by a significant 8-9% since 2017 (see G10 FX valuation: Why the dollar is not screamingly expensive). This translated into GBP not being very cheap before the Covid-19 related market sell-off (based on our estimates, sterling was by and large fairly valued both vs EUR and USD at the start of the year). This means that the recent GBP slide did not bring sterling into a meaningfully undervalued and stretched territory. GBP is currently undervalued vs USD, but as Figure 3 shows, the undervaluation is not extreme. It is still not outside of the one and half standard deviation band (vs the undervaluation for other G10 cyclical currencies). The lack of extreme mis-valuation means that at this point, the GBP valuation may still not act as a smoothing factor for GBP and the currency can fall more before hitting some valuation limits.
Figure 3: GBP cheapened up, but not to extreme levels
Market concerns about economic outlook
The shaky sterling fundamentals is likely to keep the currency exposed, despite the already announced strong fiscal response from the UK authorities. With the spread of Covid-19 affecting the economy and the UK still moving towards the measures already implemented in Europe (that are to affect the economy even more negatively) the outlook for sterling does not look optimistic. Indeed, the (denied) news that London may be 1-2 days way from a lockdown and its negative effect on GBP today provide a case in point. On the monetary policy side, one more BoE rate cut and the reintroduction of QE appear a question of when rather than if. Of course, UK-EU trade negotiations remain in the background, but the Covid-19 global crisis means that any conclusion this year seems unlikely at this point.
Tricky position
The GBP position remains shaky in the current market environment and the risks to GBP remain skewed to the downside, particularly if the USD funding squeeze remains in place and the deleveraging among the investors' community continues. Unless markets calm down, GBP/USD 1.10 level can no longer be ruled out.
Download
Download article"THINK Outside" is a collection of specially commissioned content from third-party sources, such as economic think-tanks and academic institutions, that ING deems reliable and from non-research departments within ING. ING Bank N.V. ("ING") uses these sources to expand the range of opinions you can find on the THINK website. Some of these sources are not the property of or managed by ING, and therefore ING cannot always guarantee the correctness, completeness, actuality and quality of such sources, nor the availability at any given time of the data and information provided, and ING cannot accept any liability in this respect, insofar as this is permissible pursuant to the applicable laws and regulations.
This publication does not necessarily reflect the ING house view. This publication has been prepared solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ING does not represent that it is accurate or complete. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. Unless otherwise stated, any views, forecasts, or estimates are solely those of the author(s), as of the date of the publication and are subject to change without notice.
The distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose possession this publication comes should inform themselves about, and observe, such restrictions.
Copyright and database rights protection exists in this report and it may not be reproduced, distributed or published by any person for any purpose without the prior express consent of ING. All rights are reserved.
ING Bank N.V. is authorised by the Dutch Central Bank and supervised by the European Central Bank (ECB), the Dutch Central Bank (DNB) and the Dutch Authority for the Financial Markets (AFM). ING Bank N.V. is incorporated in the Netherlands (Trade Register no. 33031431 Amsterdam).