Sterling initially rallied by as much as 0.9% against the dollar on 4 December as hopes built that a deal had been reached with the EU on the Brexit “divorce bill.” These gains evaporated late in the day and sterling has fallen by a further 0.4% on 5 December after the Northern Ireland DUP party, the UK government’s minority partner, raised objections to proposals for the Irish border question.
Currency fluctuations have a big impact on UK stocks, as around three-quarters of FTSE 100 revenues come from overseas. But despite this renewed weakness on political uncertainty, we don’t believe sterling will depreciate further and hence don't expect a boost to stocks.
- Sterling’s valuation is cheap. Compared with current values of GBPUSD around 1.34, we estimate a Purchasing Power Parity valuation of 1.59, while two-year swap interest rate differentials suggest a rate of 1.49.
- Undervaluation can be justified by political risks, but we believe a compromise is the likely outcome with the DUP, which is unlikely to risk another election and the loss of its political power. This should allow a deal to be reached and for talks to progress to the next stage.
- With unemployment low (4.3%) and inflation rising (3%) the Bank of England (BoE) recently raised rates for the first time in a decade. If politics don't escalate, we would expect the economy and the BoE to support a slightly stronger GBP.
So our three-month to 12-month forecast for GBPUSD is 1.36 and we expect UK equities to continue to underperform. Within Europe we prefer Eurozone equities to UK stocks.
Do you like this?
Please click below to sign up for more investment views.