The difficulty of predicting currency fluctuations in 2017
Any business or organisation that makes regular international payments will be aware of the need to monitor currency fluctuations and in many cases to take out Forward Contracts to mitigate the risks associated with currency volatility.
Unsurprisingly, Forward Contracts are on many people's minds at the moment, as the global financial landscape has rarely been so volatile and unpredictable.
Having said that, while politics changes many things, market fundamentals can still give some indications of how currency markets are likely to behave during the first half of 2017. That's why we are prepared to make some - fairly tentative - predictions for the year ahead; though it should be noted that in these tumultuous times, they really shouldn't be relied upon as anything other than educated guesses.
The implications of a hard, soft or fried Brexit
What seems clear is that Westminster will uphold the result of the Brexit vote, regardless of the legal and political hurdles that may have to be cleared. At the time of writing, there is a great deal of discussion about various types of Brexit, from soft to hard; though to my mind these are unhelpful labels, as we won't know exactly what type of Brexit we're getting until negotiations begin in earnest.
What seems likely, however, is that the pound will continue to suffer downward pressure; though in our opinion it is already undervalued, given the resilience demonstrated by the UK economy since the vote for Brexit. If we're right about this, the value of the pound may already have reached its low point.
At the same time, there is currently a huge disparity amongst bank forecasts, which seem to be driven by media speculation rather than hard data: because if the markets were still trading on data rather than fear, the pound would be significantly higher.
Certainly the Bank of England has very little ammunition with which to remedy the situation, as interest rates have been at historic lows for several years now, and further rate cuts would, in my opinion, be unlikely to have any great effect.
In fact, the weakness in the pound means that we are effectively importing inflation, as imports become steadily more expensive; which means that while it would be a desperately unpopular move amongst overstretched homeowners, the Bank of England may well be forced to raise interest rates this year, simply to counteract inflation.
However, it is worth noting that the European Central Bank has similar problems, as Brexit has led to a perfect storm in the Eurozone. So while the pound can be expected to fall as speculation rises, and particularly when Article 50 is officially triggered at the end of March, the fundamentals of the UK economy won't have changed overnight, and we think that there will quite probably be a 'relief rally' in the pound following the official announcement of Article 50.
The power of politics to disrupt markets
The disparity amongst bank forecasts can perhaps be partly explained by the political uncertainty across the west. Most notably, President Trump is still an unknown quantity as a political rather than a business leader, though the US economy is both resilient and expansionist in nature.
It's also fair to say that as the outcome of Brexit negotiations is still impossible to predict, no-one really knows who will triumph in the forthcoming general elections in France and Germany, and the continuing turmoil in Italy, compounded by a somewhat shaky banking system, could lead to Italy falling out of the Eurozone, or at least requiring strong intervention from the ECB.
So can we really make predictions for the pound against such an unsettled backdrop? Not with any great certainty. However, I'm a great believer in following tried and trusted indicators such as the Retail Price Index (RPI) and the Purchasing Manager's Index (PMI).
The strength of these indicators suggest that Sterling is currently undervalued, and could therefore bounce back strongly in Q2 once a little of the uncertainty surrounding the Brexit negotiations has disappeared.
However, having said that, we are still advising all of our international payments clients to consider Forward Contracts for future transactions, simply on the basis that they are the only way to bring a degree of certainty to the currently uncertain economic outlook.
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