G10 FX weekly – GBP slumps on Brexit fears

by: Georgette Boele , Roy Teo

In this publication: GBP slumps on Brexit fears and we expect further weakness up until the referendum. JPY strength persists – over to you Aso. We expect no coordinated response from G20. RBA to keep OCR unchanged; rate cut in May likely.

 

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GBP slumps on Brexit fears

Since Prime Minister Cameron agreed a deal with EU and announced 23 June as the referendum date, sterling has fallen sharply. Although, financial market already widely anticipated that the referendum would be held in June, by officially setting the date Brexit risks have come more into focus. In addition, news on Sunday that London Mayor and Conservative political heavy weight Boris Johnson will campaign for UK exit from the EU was seen as increasing chances of a Brexit. Since then, sterling has been under heavy pressure. GBP/USD has dropped below 1.40 and EUR/GBP has surpassed 0.79. Although a Brexit is not our base scenario, we have been negative on sterling versus the US dollar since November 2015 because of a delay in BoE rate hikes, a weaker economy and fears about Brexit ahead of the referendum. As such our short sterling versus US dollar high conviction view has been our top-performing trade this year. We expect GBP/USD to move towards 1.35 ahead of the referendum. We expect the upside in EUR/GBP to be limited though because of more aggressive monetary policy stimulus by the ECB.

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JPY strength persists – over to you Aso

In the past week, the Japanese yen (JPY) strength has persisted as global growth concerns remain and geopolitical risks between South and North Korea continued. However, there are also other dynamics.  First, the yen has failed to move lower on days that investor sentiment is rather positive. Second, expectations about the yen have been revised upwards with some analysts no longer expecting weakness in the yen going forward.  The yen retested the 111 level against the US dollar on 24 February as officials from Japan Finance Ministry refrained from verbal interventions. In our view, conditions for currency intervention are in place as the yen has appreciated by 17% against currencies of its main trading partners since June 2015.

Speculative flows into the yen and volatility in the currency are also extreme. We maintain our view that Finance Minister Aso is likely to take action and intervene in the currency market if the current one sided JPY strength persists. In addition, a stepping up of BoJ’s monetary easing should also weigh on the yen.

We expect no coordinated response from G20

The G20 finance ministers and central bank governors will convene in Shanghai on 26-27 February. They are likely to address issues like the sharp correction in financial markets and global economic risks as well as what should be done to support growth. The probability of a major coordinated response from G20 members is low. The People’s Bank of China may reassure the G20 that it is not seeking to devalue the yuan and changes in the exchange rate regime since August last year was to let the yuan be more reflective of China’s economic fundamentals and more market determined.  Japan Finance Minister Aso is likely lobby to clear the way for intervention in currency markets if deemed necessary. Overall, the G20 may repeat that competitive devaluation of currencies is not desirable.

RBA to keep OCR unchanged; rate cut in May likely

The Reserve Bank of Australia (RBA) is widely expected to leave monetary policy unchanged on 1 March. We expect the RBA to signal that downside risks to Australia’s major trading partners’ growth outlook have increased. We maintain our view that with subdued inflationary pressures and soft labour market, there is scope for the RBA to cut the Official Cash Rate (OCR) by 25bp to 1.75% in May. We expect the Australian dollar (AUD) to decline towards 0.65 by the end of this year.

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