British Pound Forecast

Q1, 2018
Martin Essex, MSTA, Analyst and Editor
martin.essex@ig.com
https://www.twiter.com/MartinSEssex

Christopher Vecchio, CFA, Senior Strategist

christopher.vecchio@ig.com
http://www.twitter.com/CVecchioFX

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British Pound’s Enjoyment of Brexit Talks Progress

May Be Short Lived in Q1 2018
The British Pound defied most analysts’ predictions by strengthening markedly against the US Dollar in
2017 and saw that strength spread versus the commodity currency bloc and the low yielding safe havens.
The Sterling even held its own against the Euro despite what seemed at times to be a shambolic approach
to the Brexit negotiations by the UK with the EU (in a surprising but revealing turn of events, Brexit
Minister David Davis admitted there were no white papers on the impact of Brexit on the economy,
despite promising otherwise all year).

While the British Pound is finishing Q4 2017 on a positive note after the unexpected breakthrough in the
Brexit talks regarding citizenship, the divorce bill, and the Irish border; it doesn’t appear that momentum
will carry through into Q1 2018. In mid-December 2017, it was announced that round two of the Brexit
negotiations wouldn’t begin in earnest until March 2018, leaving plenty of time for national UK politics to
upset the situation.

Indeed, it’s still not impossible to imagine Theresa May being replaced as UK Prime Minister by the
governing Conservative Party, a government collapse leading to the third general election in four years
(which hasn’t happened since 1922-24), or further moves towards independence by the UK regions – all
of which would likely hit the currency.

Any sign of a so-called “hard” or “cliff-edge” Brexit, in which the UK leaves the EU without an agreement
in place, would be taken badly too. Moreover, the Brexit negotiations could well become even more
heated as they turn to trade and related issues, and brinkmanship becomes the norm alongside continuing
arguments between May and the hard-right Brexiteers in her party.

The interest-rate outlook is unlikely to be supportive either. The Bank of England doubled its benchmark
rate to 0.50% in early November, raising it for the first time since 2007 and reversing its reduction
immediately after the Brexit referendum in June 2016. However, as of the time of writing this note in mid-
December 2017, rate hike expectations weren’t pricing in the next BOE rate hike before August 2018 at
the earliest.

Any reassessment of the timing of an interest-rate increase, suggesting it will be brought forward, would
be positive for the Pound and such a development is not impossible. However, barring an unexpected
pickup in economic growth or sustained move by inflation above +3% y/y, it seems highly unlikely. Indeed,
even with inflation at a five-year high, consumer prices could increase even faster and a surge in wage
growth to above the inflation rate – potentially lifting the economy through even higher consumption –
can probably be ruled out.

Turning to individual pairs and crosses, GBP/USD will, of course, be driven by the Dollar side of the
equation as much as by the Pound side. On the US Dollar side, there are two big unknowns: the so-called
Trump effect on the US economy (tax reform should be wrapped up and attention could shift to
infrastructure); and the monetary policy stance of incoming Fed Chair Jerome Powell.

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If US President Donald Trump’s tax policies lift US economic growth – even in the short-term – that could
strengthen the hands of the new more hawkish members of the rate-setting Federal Open Market
Committee pressing for further hikes. For now, the Fed is expected to increase US rates three more times
in 2018, and shifts in the Fed’s rate hike timeline (the ‘glide path’ as derived from the ‘dot plot’) will surely
sway the US Dollar leg of GBP/USD.

Turning to EUR/GBP, we know already that the European Central Bank intends to “taper” – or reduce – its
asset-purchase program starting in January 2018, which will run at €30 billion per month until September
2018. However, the ECB has already made clear that an interest rate increase is still a long way away,
echoing the early stages of how the Fed unwound its QE program and shifted into tightening via rate hikes.
Additionally, now that political risk in Europe has evaporated – there are no major milestones in Q1 2018
like a French presidential election to be nervous about – don’t expect the ECB to have much influence
over EUR/GBP.

It would appear that there is tug-and-pull type effect for the British Pound going into the next quarter, in
large part thanks to uncertainty surrounding the Brexit negotiations and the collateral damage they may
cause to the May government. Barring a noticeable pickup in UK growth conditions and or reversal in
recent real wage growth losses, the Bank of England is going to be sitting on the sidelines in Q1 2018 likely
with the currency in towl.

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Technicals: EUR/GBP, GBP/USD Enter New Quarter

Struggling to Break Ranges
The British Pound enters Q1 2018 on stronger footing than it began the last quarter. In GBP/USD, a
sideways consolidation during October and November gave way to an attempt at a topside breakout in
December, with little results so far. EUR/GBP is in a similar situation, having been in a sideways
consolidation since September, with a failed attempt thus far at exiting the range to the downside. As we
turn into Q1’18, the British Pound retains its nascent bullish technical stucture, with either outcome – a
breakout resulting in more Pound strength, or a reversal resulting in Pound wekaness – still very much on
the tablle.

Chart 1: GBP/USD Weekly Timeframe (January 2014 to December 2017)

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Chart 2: GBP/USD Daily Timeframe (June 2016 to December 2017)

Taking a look at the GBP/USD weekly timeframe (chart 1 above), it’s evident that the area around 1.3500
has proved itself as a significant resistance region, having initially formed in the immediate aftermath of
the June 2016 Brexit vote. The ascending triangle that has formed against this swing area (chart 2 above)
in conjunction with the uptrend from the October 2016 low suggests that bullish potential remains.
Likewise, depending upon how you measure it, GBP/USD has started to break through the downtrend
from the swing highs between July 2014 and June 2016.. Finally, weekly MACD and weekly Slow
Stochastics continue to churn higher, buffering the bullish outlook.

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Chart 3: EUR/GBP Weekly Timeframe (September 2015 to December 2017)

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Chart 4: EUR/GBP Daily Timeframe (May to December 2017)

Taking a look at the EUR/GBP weekly timeframe (chart 3 above), a potential rising bearish wedge has
formed going back to November 2016 with EUR/GBP having already spent some time underneath the
uptrend. Similarly, since September 2017, price has been consolidating in a sideways range between
0.8745 and 0.9020. Support has been tested several times (chart 4 above), having not been able to put in
a significant move below 0.8745 since June 2017. Given the outsized net-long Euro positining in the
futures market, the favored break of the range, were it to happen in Q1 2018, would be to the downside.

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