Sell GBP/JPY, Target 158.00 Say MUFG
A pick-up in risk appetite has helped support the pound, particularly against the dollar, but MUFG expects weak UK fundamentals to put the UK currency on hold and lead to medium-term weakness.
He adds; “We continue to believe the GBP remains vulnerable to further weakness due to the weakening outlook for the UK economy which has likely already slipped into recession.”
MUFG sees selling the pound against the yen as better value than selling against the euro, especially as it sees the yen as still significantly undervalued and likely to rally amid spike in global yields .
He recommends selling the Pound to Yen exchange rate (GBP/JPY) at 164.00 with a target of 158.00.
The recovery in risk will support the pound…
According to MUFG, the latest US CPI data has helped ease financial conditions, which will provide an element of support for the British pound. He adds; “The easing of global financial conditions creates a more supportive environment for the GBP in the near term and should make it less difficult for the UK to finance its high current account deficit.”
This is important given that MUFG analysis shows that GBP/USD movements have become more highly correlated with global equity markets this year.
According to the bank, a 1.0% advance in global equities results in a 0.61% gain for GBP/USD.
If equity markets are buoyed by expectations of a less aggressive stance from the Fed, GBP/USD will tend to benefit from broader support from sterling.
However, the pound will be vulnerable if the stocks reverse.
…but weak UK fundamentals pose clear downside risks
MUFG still expects broader fundamental developments to undermine the pound and added; “We remain skeptical about the ability of the pound to strengthen on a more sustainable basis and against a broader basket of currencies given that the economic fundamentals in the UK remain unfavorable.”
According to the bank, the economy is being hit by multiple negative shocks, including deteriorating terms of trade due to rising energy and food prices, as well as tighter financial conditions as the Bank of England sells gilts.
The bank also stresses that fiscal policy will be tightened, which will have a negative impact on the economy.
Many measures will probably be postponed, which will help limit the short-term effects on the economy.
However, a lasting medium-term tightening would dampen the economy over a long period.
According to the MUFG, this tightening should help to further ease the BoE’s concerns about the medium-term inflation outlook and reduce the risk of further substantial rate hikes.
In this context, he added; “We still believe the BoE has room to disappoint these moderate rate hike expectations, which is dampening GBP performance going forward.”
The undervalued yen in global markets
The MUFG previously recommended selling the pound against the euro, but has now switched to recommending selling the pound against the yen.
He added; “Even after strong recent gains, we believe there is potential for the yen to rebound further as it remains deeply undervalued. He also expects a spike in global bond yields to support the Japanese currency.