Pound Sterling’s steady rise on a trade-weighted basis came to an end at the beginning of 2016 as investors realised that the UK would definitely hold an EU independence referendum. From a starting level of 90.37, Pound exchange rates steadily declined in the run up to June. The shock ‘Leave’ result caused GBP to tank from 87.76 to 77.70 within a matter of weeks.
A mysterious ‘flash crash’ in October pushed Sterling even lower, with Pound exchange rates striking a fresh historical low of 73.72. While several developments since have pushed the trade-weighted index up to 78.13, there are still plenty of headwinds and market fears that could drag GBP lower again as 2017 progresses.
Here is a look at the biggest risks for the Pound over the coming months.
Pound Wobble Forecast as Theresa May triggers Article 50
This is likely to weaken Sterling, as it means markets are in for two years of rumours, hearsay and posturing as the UK negotiates its way out of the EU. Investors don’t respond well to uncertainty, so the Pound could see recent gains eroded.
Inflation Outlook to Unsettle GBP
While many of the prophesised side-effects of voting for Brexit have not materialised thus far, the weakening of Pound exchange rates has been in line with market predictions. This has already significantly inflated consumer prices. However, wage growth in the UK continues to remain sluggish. This makes it harder for households to deal with rising prices, which could slow consumer spending.
Economic Imbalance Could Soften Sterling
The UK economy continues to rely entirely on a strong service sector in order to expand. However, most forecasts currently expect weak Sterling and rising inflation to slow consumer spending, which will weaken the services sector. This could potentially drastically slow the UK’s economic expansion.
Signs of Hawkishness from the Bank of England (BoE) Would Boost GBP
The BoE have repeatedly tried to downplay the current strength of inflation. Policymakers had initially commented after the referendum that they would ignore strong inflation when setting interest rates, instead focussing on the underlying economic fundamentals. Markets are on the fence about whether or not there will be a rate hike this year, but should the BoE be seen to be leaning towards monetary tightening, the Pound could rise significantly.
Long-term Pound Exchange Rates Forecast; Key Data to Watch Out For
With the services industry clearly an important focus for the economic outlook, each Markit services PMI is likely to generate even more volatility than it did before the referendum. The UK consumer price index will be important, as will accompanying wage growth data. Although usually considered low-impact, the British Retail Consortium (BRC) and Confederation of British Industry (CBI) reports could be subject to greater scrutiny, as these will show how retailers and manufacturers are coping with the strong rise in prices caused by weakened Pound exchange rates.
Of course, news from the Bank of England, including the quarterly Inflation Reports, will also be of considerable interest.
