Pound to Dollar Forecast at Parity by El-Erian and Magnus Provided Leadership Vacuum Persists

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Two prominent financial market sages have come forward and warned that unless some clarity on the future is provided by UK politicians the GBP / USD exchange rate is at risk of a fall to parity.

With the implications of the UK’s Brexit vote begin to sink in, research analysts see protracted downside risks for sterling.

A good majority of those analysts we follow now expect GBP/USD to trade down to 1.20 by the start of 2017.

However, the balance of risks to these forecast are currently skewed to a larger decline.

Key to the depreciation will be the Bank of England which is expected to cut interest rates lower, to perhaps 0%.

All the while expectations for another interest rate rise in the United States in 2016 keep the USD buoyed.

George Magnus, the independent economist and commentator who was Chief Economist at UBS from 1995-2012, says that the prospect of GBP/USD falling to parity is real.

“I said before the referendum it would most likely fall by 20 per cent, and that still looks likely. If the economy really shuddered, parity is quite possible,” says Magnus.

The big variable to note is “if the economy really shuddered”.

What such a shudder looks like is unclear.

“I personally expect a recession to take hold, starting with a slowdown in the third quarter. Lending and spending decisions, especially when it comes to house purchases and investment, normally go on hold under conditions of uncertainty, of which we have more than enough,” says Magnus.

Magnus is not alone in his expectations for recession, as we have noted recently, a good number of institutional economists are also warning of recession.

“It matters, of course, whether we do experience a recession, not least to those who will lose their jobs, or have to weather wage stickiness. But it will also matter a lot to the Government’s fiscal position which would deteriorate sharply,” says Magnus.

For export-oriented companies, the fall in the Pound is a mitigating factor in the outlook.

Standard economic thinking suggests that the fall in the pound will stimulate UK industry via the export channel.

A fall of 10% in the Pound trade weighted index would suggest that UK goods and services just got 10% cheaper on the international market place.

This should stimulate bargain hunting.

“There is no question a cheaper Pound will help some companies but it depreciation is most unlikely to offset other economic problems the UK is going to encounter,” argues Magnus.

Magnus cites the following headwinds to UK exports:

• world trade is stagnating and there is no productivity miracle occurring, as there was then with information technology
• China and several major emerging markets have lapsed into a growth hiatus of unknown duration, when in the earlier period they were starting to make their presence felt
• global growth is weak and fragile, whereas it was accelerating quickly 20 years ago
• the UK’s balance of payments deficit is a large 7 per cent of GDP, about 3 times as big as it was before
• the ERM debacle, and lack of confidence in the Pound, could make financing the deficit more troublesome

El-Erian Warns on GBP/USD Parity

Mohamed El-Erian, Economist at Allianz, is also warning that the Pound could reach parity against the US dollar.

In an interview with Reuters the former head of PIMCO said the big cloud hanging over the British pound at present is a leadership void in the UK.

With Cameron gone, and the government seemingly lacking a ‘Plan B’ - otherwise known as a plan for a Brexit vote - investors and businesses are unable to plan for the future.

As noted by Adam Jepsen, writing in Pound Sterling Live, “what is clear is that there's no Plan B for Brexit and there was no Plan A either. The prolonged period of uncertainty just got longer.

“Once the impact of the referendum starts to filter through to more of the UK's economic data it should start to show the gravity of the situation. Market volatility could get worse.”

El-Erian agrees and says the UK has to urgently get its political act together accusing politicians of shirking their economic governance responsibilities.

"Think of Sterling as facing a double whammy with no strong anchor," says El-Erian.

He adds:

"The future value of sterling is a function of how and how quickly the structural uncertainty is resolved – if Plan B is delayed and/or it doesn't involve much of a free trade set-up with the EU, it is not inconceivable for sterling to head to parity with the U.S. dollar,” says.

El-Erian believes that should timely agreement between the UK and its European partners on a new arrangement that allows for sufficient free trade access, sterling could end up appreciating from its current levels."

“The chatter on forex desks is that the pound could hit parity with the dollar. Although not impossible, this seems a little far-fetched as sterling would have to drop considerably from where it is now," notes Andrew Edwards, CEO of ETX Capital.

Parity would represent an all-time low for the pound.

The consensus forecast amongst surveyed analysts currently stands at 1.20.

Edwards believes much rests with how the Bank of England acts at their July meeting, and argues that doing nothing could actually achieve more than doing something:

"Some are calling for the Bank to hold fire and leave rates as they are – which may be the sensible move. Increasing credit supply doesn’t achieve much if there is no demand and it’s the demand side that matters most.

"A firm vote to hold rates where they are would send a clear signal to investors that the Bank is confident the UK can weather this storm and that it doesn’t want the pound to drop further. Keeping its powder dry would mean it has ammunition for another day, should financial conditions get a lot worse."

What are the chances of an interest rate cut in July, and what are the chances for two interest rate cuts to take place in 2016?

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