GBP: Relative appeal boosted by shift in BoE policy focus and rising political uncertainty outside UK - MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the pound has benefitted from the sharp adjustment higher in UK yields following the US election which has reinforced the upward moment for real yields which bottomed just after the flash crash.

Key Quotes

“The recent move higher in UK yields has played catch up with higher inflation expectations resulting from the sharply weaker pound and is helping to offer it more support.”

“The BoE’s recent shift to a neutral policy stance has provided more support for the pound. The BoE has clearly signalled that pound weakness is becoming more of a policy concern with further weakness likely to challenge their tolerance to allow a “temporary” inflation overshoot. Further clarity on the recent shift in policy thinking at the BoE will be evident today when Governor Carney, Deputy Governor Shafik and MPC member Saunders will be speaking before the Treasury Select Committee.”

“The release of the latest UK CPI report for October will also be watched closely to assess the build-up of inflation pressures. The BoE expects inflation to peak at just below 3% in the coming years. The outlook is broadly similar to price behaviour following the global financial crisis when inflation averaged 3.5% between 2010 and 2012 after the pound lost around a quarter of its value.”

“The UK’s vote in favour of Brexit no longer appears so isolated following a similar uprising of anti-establishment sentiment helped to elect President Trump. It may now mark the start of a trend thereby increasing political risk ahead of upcoming elections and referendum in Europe in the year ahead. After already adjusting sharply lower the pound is better priced for higher political risk. A shift in focus away from the UK would help to improve the relative appeal of the pound. A rise in European political risk in the year ahead could result in the pound outperforming relative to bearish expectations. During the euro-zone debt crisis the pound benefitted from being viewed as a regional safe haven.”