Pound Sterling Forecast for 2018: Can GBP Recover as Brexit Trade Negotiations Begin?

GBP 2017 Round-up: Fears Over Brexit and UK Economy Batter Sterling, but Pound Exchange Rates End the Year Higher

2017 was a packed and volatile year for Pound Sterling. Political chaos, stalled Brexit negotiations, uncertainty surrounding the resilience of the UK economy and stubborn Bank of England (BoE) policymakers all had an impact upon the Pound.

The Pound to Euro (GBP/EUR) exchange rate ended the year down over -3.6%, while the Pound to US Dollar (GBP/USD) exchange rate is up nearly 10% on the levels seen at the end of December 2016.

Sterling also ends the year higher against the commodity trio: the Australian Dollar, New Zealand Dollar and Canadian Dollar.

However, against all its major peers the Pound is still far below the levels seen in the run-up to 2016’s Brexit referendum.

How is Brexit Forecast to Impact Pound Sterling Exchange Rates in 2018?

Preparations for the UK’s exit from the European Union in 2019 will continue to be the biggest issue over the coming 12 months.

In terms of the actual negotiations, markets may have to wait until the end of Q1 to find out what the UK and EU’s opening offers are, as the second phase of talks is not expected to begin until March – a year after Theresa May formally triggered Article 50.

In order to give the EU ample time to ratify any deal, the two parties need to have reached an agreement by October at the latest, which would leave the UK just seven months for negotiations.

This is a worrying prospect as far as the markets are concerned, as it took nine months for Brexit Secretary David Davis and his team to conclude the first phase of negotiations.

Preliminary talks on issues such as the divorce Bill, the rights of EU and UK citizens residing in one another’s territories and the Irish border were supposed to be concluded quickly; Theresa May’s weak grip on power, cabinet infighting and diplomatic gaffes all complicated what was expected to be a straightforward process.

As Goldman Sachs analysts noted before an agreement was reached in December regarding the first phase of negotiations;

‘While the prospects for a Brexit breakthrough in December have grown, that even such a small step has proved as tortuous is a testament to the difficult journey ahead. Backing away from its most important trading partner was always likely to be costly for the UK economy, but any setback on the transition deal or a slow pace of negotiations on a future trade deal will likely only increase costs to the UK.’

How will UK politics affect GBP in the coming year? Will there be a general election in 2018?

The latter half of 2017 saw Theresa May and the Conservatives struggle to recover from a disastrous snap election held on the 8th June.

After months of claiming that she would not call a general election following her succession of David Cameron as Prime Minister when he resigned after the Brexit referendum results were announced, May sought to capitalise on strong poll readings and further her majority in Parliament.

This would have made it much easier for her and her Cabinet to force through their vision of Brexit, with Theresa May aiming for a ‘hard exit’ in order to appease the most vocal members of her cabinet, such as Boris Johnson and Michael Gove.

However, Jeremy Corbyn’s Labour Party saw a surge in support and May was left with insufficient MPs to control the House of Commons on her own.

Will May’s Relationship with Northern Ireland’s DUP Force a 2018 General Election?

After frantic talks with Northern Ireland’s Democratic Unionist Party – which many argued broke the terms of the Good Friday Agreement – Theresa May managed to secure the support of the party’s 10 MPs, at a cost of £1 billion in extra funding for Ireland.

However, the arrangement has not proven as beneficial to the Conservatives as May might have hoped, with the DUP nearly stymieing phase one of Brexit talks at the final hurdle after refusing to accept the government’s concessions to the EU on the Irish border.

The party has also sided with Labour and Tory rebels on at least one occasion to block government legislation.

This political weakness could leave Theresa May struggling to negotiate with EU leaders, who fear she lacks the political clout back home to negotiate a Brexit that will actually be approved by her own Parliament.

According to Morgan Stanley analysts Jacob Nell and Melanie Baker, May’s only option could therefore be to call another general election: ‘With a minority government torn over Europe and facing a divisive choice between ‘taking back control’ and maintaining close links, we see another early election as likely.’

Will UK GDP Recover and Boost Pound Sterling (GBP) Exchange Rates in 2018?

Although the Pound has been primarily driven by political developments during the course of 2017, economic data has still thrown up plenty of surprises to keep Sterling volatile.

After accelerating to a 12-month high of 0.7% in the final quarter of 2016, GDP figures for this year have proven less inspiring; economic growth slumped to 0.3% in Q1 and stayed at that level during Q2.

An uptick to 0.4%in Q3 was a welcome move in the right direction, but markets couldn’t ignore the fact it was still below the level seen for most of 2016.

Societe Generale Macro Strategist Kit Juckes believes the outlook for 2018 will also be gloomy, with the UK economy lagging behind that of other major players.

Juckes stated: ‘We expect three years of real GDP growth below 1% in 2018-2020, averaging 0.8% per annum, about a quarter of the world’s average growth rate.’

UK 2018 Economic Outlook: Can Services Sector Find Solid Ground and Boost Sterling?

The monthly release of purchasing managers’ indices (PMIs) from IHS Markit always cause significant volatility for Sterling.

Chief amongst the releases is the index for the services sector, as this accounts for around 80% of the UK’s economic output.

Given that inflation remains at multi-year highs, while wage growth continues at a sluggish pace, many economists are concerned that households simply cannot keep up the levels of spending required to power the UK economy onward.

The services PMI has fluctuated wildly over the course of the past year, trending between highs of 56.2 and lows of 53.3.

Further signs of weakness in the service sector would weigh on Pound exchange rates, while signs of a more sustained uptrend could light a fire under Sterling.

GBP Exchange Rate Outlook for 2018: Are Political, Brexit and Economic Risks for the Pound Likely to Push Sterling Higher or Lower?

The biggest influencers of Pound Sterling exchange rate movement in 2017 will continue to dominate market sentiment in 2018.

Markets want to see the UK and EU agree a transitional period for Brexit, during which the UK can adjust to life outside the EU and negotiate trade agreements with other nations, preventing the shock of a ‘cliff-edge Brexit’.

If this can be agreed early in the negotiations likely starting in March, GBP could find some support; if there is no transitional deal and it seems unlikely the EU will grant the UK favourable trade terms, then the Pound could weaken.

If the economy continues to give out signals suggesting only muted growth, or even further slowdown, markets will react negatively – not only is this bad for the nation’s businesses and consumers, but also for the odds of the Bank of England (BoE) opting to hike interest rates again any time soon.

Are Pound Sterling Exchange Rates Overvalued or Undervalued?

The Pound could be spared from extreme depreciation due to the fact that markets have already priced-in much of the negative aspects of Brexit and monetary policy.

Although investors still fear a ‘Hard Brexit’ or a ‘no deal’ scenario, the risks of these are already well accounted for in Pound Sterling exchange rates, muting the extent to which GBP may fall on more negative developments.

As Commerzbank Chief UK Economist Peter Dixon explains; ‘I think the markets got their retaliation in first back in June and September last year. Ever since then, they have been a lot less negative. If you look at the market positioning of Sterling, it has turned moderately positive. It went heavily negative in 2016, but it is now flat. Under those circumstance, that suggests that markets themselves have a less negative view of where Sterling goes from here.’

Not all analysts believe the Pound is as low as it should be, though, with many arguing that it remains overvalued.

BNP Paribas analysts stated: ‘Our view remains that the UK faces a number of cyclical economic and political challenges and, with the GBP rich versus estimates of its short-term fair value … and investor positioning fairly neutral, we see considerable scope for GBP weakness over the next six months.’

It’s a belief shared by analysts at UBS, who explained: ‘Brexit and the UK’s external imbalances have been central to our negative view on Sterling for a while. Our FEER model screens Sterling as c. 20% over-valued in TWI [trade weighted index] terms even after the substantial drop since the Brexit referendum, as the UK current account has yet to correct to more sustainable levels.’

What Does 2018 Hold for Pound Sterling?

The ongoing Brexit negotiations and uncertainty surrounding the economy as the UK enters uncharted waters makes it particularly difficult to forecast how Pound Sterling will trend over the course of 2018.

One thing is for certain, however; the political, foreign policy and economic fronts will all throw up numerous complications and surprises over the next 12 months.

It looks set to be another volatile year for Pound Sterling exchange rates.

Laura Parsons

Laura has been working in the financial services sector since 2012 and provides currency news updates for a number of online and print publications. Over the years she has produced exchange rate analysis for publishers like French Property News, The Express, The Telegraph and Forbes.

Contact Laura Parsons