BBVA forecasts sterling relief in November

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Sterling could see a relief rally in November if the UK and the European Union reach a compromise on Brexit, especially if positive news arrives in a market that is positioned for further bad revelations, says Alexandre Dolci, a G10 FX strategist at BBVA.

Between now and then, however, the pound is set for a continuation of its recent bumpy ride, as the possibility of a no-deal Brexit looms.

Dolci’s base-case scenario holds that the divorcing countries will reach a mutually acceptable agreement by mid-November, allowing time for national parliaments to vote on the proposals ahead of the UK’s departure deadline of March 29, 2019.

“A compromise by mid-November could then pave the way for a relief rally in sterling, as the market seems to be rather short for the time being,” says Dolci.

Assuming BBVA’s expectations prove correct, Dolci sees sterling benefiting from a relief rally, and hitting $1.35 by December and then $1.44 in 12 months’ time. A failure to reach a deal could see cable spiralling down to $1.20 from the current $1.32 level.

“Until mid-November, the road could still prove to be quite bumpy for sterling. We would not rule out wild gyrations in sterling crosses and volatility to rise until then,” he says.

We wouldn’t be surprised if [Donald Trump] stepped up his belligerent rhetoric against the Fed, the EU or China. This will weigh on the dollar

Alexandre Dolci, BBVA

But sterling’s vulnerability will be somewhat balanced out by the dollar’s own wobbles, as mid-term elections approach and US president Donald Trump switches into campaign mode.

“We wouldn’t be surprised if he stepped up his belligerent rhetoric against the Fed, the EU or China. This will weigh on the dollar,” Dolci says.

BBVA, which topped FX Week’s one-month G10 forecast table last week, expects the dollar to give up part of its recent gains. It forecasts EUR/USD to reach 1.21 by the end of the year, up from 1.18 at pixel time.

December hike

Still, despite the intensification of trade tensions as a result of the start of US tariffs on $200 billion worth of Chinese imports, and China’s retaliation in kind, the Federal Reserve hiked its key interest rate at its September meeting for the third time this year, pushing key rates to 2.25%. Dolci expects the US central bank to hike rates again in December.

“The dollar should barely benefit from extra rate hikes by the end of this year. The focus is more on whether the Fed can keep the same pace of tightening in 2019 as they had in the past two years,” Dolci says.

“The euro area is not at the same advanced stage in the economic cycle as the US and has more room for improvement, particularly if we take the unemployment rate as a metric of slack in the eurozone economy. The euro area has a few more years of growth compared to the US,” he adds.