Sterling Monthly Outlook
12th June 2014
Sterling-dollar trades directly in line with the UK-US 2 year yield differential. Sterling dollar price action is effectively a tug of war between which central bank will hike interest rates first. With the UK reaching 3% annual growth rates and the US ambling along at just 2%, the Bank of England is now the front-runner to hike. This explains sterling persistent appreciation against the dollar since the new year. However appreciation has been slow with volatility at record lows. One reason is that we are effectively arguing over a mere 25basis points hikes one year from now. The market is also extremely long the pound meaning trade is susceptible to short term shake outs as sterling looks set to reverse a substantial part of its post-2008 correction lower.
The biggest risks to a stronger sterling-dollar is a sharper than expected rebound in the US economy and US inflation fears pricing in earlier rate hikes. The ECB aggressively easing policy could also pose a threat to short term sterling appreciation, although most of this is likely to be played out in the euro-sterling cross. We have to balance these concerns against gaining UK growth and the natural calls for higher interest rate as a result. As such we believe the overall direction for sterling-dollar is higher. We forecast $1.69, $1.72, $1.74 and $1.73 for Q2, Q3, Q4 2014 and Q1 2015 respectively.
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