Brexit risks set to weigh on GBP ahead of EU referendum – Danske Bank

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Mar 23, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    Research Team at Danske Bank, notes that the UK economy grew 0.5% q/q in Q4, driven mainly by consumer and government spending while both investments and exports contracted.

    Key Quotes

    “It is likely that both GDP growth and employment growth will slow in H1 16 due to increased uncertainties ahead of the referendum which could hamper investments and private consumption. This is also reflected in the business survey where e.g. both manufacturing and service sector PMIs declined in February. UK CPI inflation increased to 0.3% y/y in January from 0.2% y/y in December. CPI inflation and CPI core inflation are expected to remain subdued in 2016.

    Monetary policy. The Bank of England (BoE) kept both the Bank Rate at 0.50% and the stock of purchased assets at GBP375bn in March. As such, the BoE has tied its hands ahead of the EU referendum, and we expect UK money market rates to remain fairly stable. We think there are many reasons for the BoE to stay on hold for an extended period: i) subdued inflation and wage growth, ii) other central banks have adopted a more dovish stance and iii) not least, Brexit uncertainties, to name a few. We still expect the BoE will increase interest rates in Q1 17, but with the great uncertainty surrounding the EU referendum, things could change rapidly after it. The market is pricing the first rate increase in Q2 19.

    Flows. Investors are speculatively short GBP but positioning is not significantly stretched.

    Valuation. PPP is around 0.77 while EUR/GBP is overbought, according to our short-term financial models.

    Risks. The upcoming EU referendum represents a significant event risk to GBP and a medium- to long-term risk factor for the UK economy .

    Given the high uncertainty surrounding the EU referendum, we see risks skewed to the upside for EUR/GBP ahead of 23 June. A substantial Brexit risk premium has already been priced into the FX option market, and further significant GBP selling pressure is not likely to be seen before we come closer to the referendum. However, volatility is likely to remain high and EUR/GBP is likely to be very sensitive to news flow, changes in polls and so on.

    We forecast EUR/GBP at 0.80 (0.79) in 3M and think it may inch even higher ahead of the referendum day. Longer term, the outlook for EUR/GBP very much depends on the outcome of the EU referendum. In our main scenario, we assume a status quo for the UK, meaning that people vote to remain in the EU. This implies that GBP should appreciate immediately after the referendum. Longer term, we project further EUR/GBP downside driven by relative growth and relative monetary policy. We target EUR/GBP at 0.74 in 6M and 0.73 in 12M but stress that these forecasts are subject to significant digital risk.”
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