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Will the Pound Emulate the US Dollar’s Strength in 2016?

David Meyer - Author
By

Aug. 18 2020, Updated 5:14 a.m. ET

Things to watch for regarding the pound

The Bank of England’s impending rate hike and the Brexit referendum will be the major currency drivers in 2016. The Bank of England is in line to be the next developed market to go for a rate hike after the Fed. Now that the Fed’s rate hike is done, the focus will be on the Bank of England. Will it finally decide to increase the rates?

The situation for the pound sterling in 2016 is similar to the US dollar’s situation in 2015. The markets are expecting a rise towards mid-2016. This would mean that the pound might garner strength against other currencies like the euro and Canadian dollar. The US dollar is also expected to strengthen. The pound-US dollar pair may not show much upside. However, with the ECB continuing to weaken the euro, the pressure will be on the Bank of England to delay the rate hike as much as possible.

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Do the fundamentals warrant a hike?

The Fed’s rate hike put the onus on the Bank of England about whether or not to go for a rate hike. It will still depend on a wide range of macro indicators. The major positive indicator would be the employment figures and consumer spending. They have been coming out on a positive note. The trade balance and core inflation numbers for recent months have been disappointing. The trade deficit hasn’t ever been this high even during the crisis times. This casts doubt on whether the Bank of England will move ahead with the hike in 1H16. Unless there’s a marked improvement in the macro indicators, the rate hike may not happen as early as the markets have been anticipating. We expect the hike to be delayed towards the end of 2016. This could cause the currency to weaken in 1H16. However, we expect a stronger pound later in the year.

Potential impact of the Brexit referendum

Another major factor that can cause volatility in the pound is the Brexit referendum. In 2015, there was high volatility during the Scottish referendum and the United Kingdom’s general election. A similar level of volatility is expected from the Brexit referendum. It’s expected to happen or get a strong level of indication in 2016. “Brexit” refers to the exit of the United Kingdom from the EU (European Union). Initially, it could have a substantial impact on the economy. In the long run, it’s expected to be negative for the United Kingdom’s economy. The referendum dates and the results, if it happens in 2016, will be another major factor that would determine the direction of the pound-US dollar currency pair.

Impact on the market

The First Trust United Kingdom AlphaDEX ETF (FKU) rose by 3.9% through the year from January 2, 2015, to December 28, 2015.

British ADRs (American depositary receipts) ended on a negative note in 2015. Rio Tinto (RIO) ended lower by 35.7%. Banking ADRs were in a negative trajectory as HSBC Holdings (HSBC) fell by 15.0% while Barclays (BCS) fell by 11.5%. The Royal Bank of Scotland Group (RBS) also posted losses of 23.9%.

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