• The GBP/USD gained in 1Q2018 by 3.1% to end at 1.402, which turned out to be slightly weaker than our 1Q2018 projection of 1.410.

• Our long-term outlook on the GBP/USD suggests the currency should exhibit an appreciating trend until 2023, supported by macro fundamentals with a weakening USD cycle that should hit the bottom also by 2024.

• The GBP/USD should gain in 2018 to around 1.440 – 1.450 and possibly reach the 1.460 levels. The strengthening momentum should continue in 2019 and settle around the 1.490 levels supported by improving macro fundamentals, unwinding of the bond-buying programme and potential interest rate hikes.

• Investors are seen chasing faster growth and rising returns elsewhere, given an improved risk appetite in markets and the fairly mature stage of the US economic cycle.

• While we project a stronger GBP/USD in 2018 and 2019, we expect the GBP/USD to experience volatility along the path driven by noises. Besides, we envisage the US bond yields rising rather than falling partly due to a tightening monetary policy, which offsets some of the need for the USD to depreciate.

• Against the Malaysian ringgit (MYR), we expect the pound to exhibit some strengthening from the BoE’s expected continued rate hikes in 2018 and 2019. In the case of Malaysia, the monetary policy tightening is almost at the mature stage with the policy rate envisaged to normalise at 3.50%, providing another 25bps upside.

A. GBP/USD stronger in 1Q2018

• Exciting month for GBP in January: The pound gained 5.1% to 1.419 against the USD in January. During the month, the GBP traded between 1.351 and 1.424, with its monthly average at 1.381. The GBP/USD was supported by: (1) a weaker USD; (2) inflation though easing, is still higher than the 2% target; and (3) healthy average earnings growth which expanded 2.5% in 4Q2017, thus fuelling expectations of a more aggressive rate hike in.

• GBP eases in February: The currency saw a pullback in February against the USD where it fell by 3.5% to 1.376 against the USD. The currency traded in a range of 1.376 and 1.426 with the monthly average at 1.396. The weaker GBP was due to the global selldown following the UST 10-year bond yield spiking to a record high of 2.95% on 21 February when the markets priced in a four-rate hike by the US Fed in 2018 as opposed to three (3) after the release of strong wage growth data of 2.8% y/y in January. However, the downside to GBP against the USD was capped as the Bank of England (BoE) turned hawkish during February’s monetary policy meeting, though rates were left at 0.5%.

• Strong GBP in March: In March, the GBP gained 1.7% to 1.402 against the USD. It traded between 1.378 and 1.423 against the USD despite jitters in the global markets on expectations the Fed will adopt a more aggressive rate hike approach and Trump’s trade war rhetoric. The increasingly hawkish tone signalled by the BoE for a rate hike in May provided the booster for GBP to remain firm against the USD. Besides, the UK struck a provisional transition deal with Brussels with regards to Brexit’s 21-month transition period.

• Overall, the GBP in 1Q2018 strengthened 3.1% to 1.402 against the USD. The GBP ended 0.57% weaker than our 1Q2018 forecast of 1.410 against the USD to settle at 1.402.

B. Long-term outlook on GBP/USD & DXY

• We examined the GBP/USD outlook to determine the long-term cycle. From our analysis, the GBP/USD will strengthen for about 5.3 years with an average appreciation of 10.9%. Meanwhile, the weakening cycle lasted for 7.3 years with an average depreciation of 6.2%.

• Since the GBP/USD started exhibiting its appreciation momentum in 2017, we believe the strengthening momentum should last until 2023 when the currency should peak (see Chart 1).

• Apart from macro fundamentals, the long-term strengthening momentum of the GBP/USD is also being supported by a weaker USD long-term momentum. From our observation, we found the DXY to experience a 7-year downcycle with an average fall of 7.8% while the upcycle is close to 9 years with an average gain of 6.6%. Based on our findings, we foresee the DXY exhibiting a weakening trend until 2024 (see Chart 2).

C. GBP/USD to strengthen in 2018 & 2019

• We expect the GBP/USD to be on a strengthening mode for 2018. We expect the currency to hover around 1.435, with room for it to reach the 1.445 levels. In our projection, we foresee the GBP/USD gaining from 1.402 end-March to our projection of 1.420 end-June and reach 1.430 end-September before settling at 1.450 end-December.

• In 2019, we believe the GBP/USD will remain strong. The currency should strengthen to 1.49 by end-2019. We believe the GBP/USD will reach 1.460 end-March and further strengthen to 1.470 end-June, and 1.480 endSeptember before settling at 1.490 end-December.

• Key drivers for a stronger GBP/USD are:

1. We expect Brexit-related headwinds to domestic demand to abate in 2018, and the economy to regain traction on strong global and European growth. We envisage GDP to grow by 1.9% in 2018 supported by improving consumer confidence as well as business and investment sentiments, better public finances and a continued recovery in manufacturing and exports on the back of stronger global GDP (see Chart 3).

2. Inflation is now easing although it is still above the 2% target. Wages are improving. A combination of these two is likely to see real wages increase, giving more disposable income to the households that should see an increase in spending. It will be due to improving consumer confidence (see Chart 4 & 5).

3. With the unemployment rate at a three-decade low and inflation though easing, is still above the 2% BoE target, it depicts inflationary pressure coming from the demand side. This encourages the central bank to raise interest rates in 2018. We are looking at a rate hike in May and another either in November or December (see Chart 4 & 6).

4. Improving public finances is a positive pull factor for investors, and a boon for the GBP. We expect the UK’s combined current account surplus and fiscal deficit to improve to -5.4% of GDP in 2019 from -6.5% of GDP in 2018. This will provide support to the GBP/USD and can result in a moderate overvaluation (see Chart 3, 7, & 8).

5. Investors are expected to chase faster growth and rising returns which should support the GBP, given an improved risk appetite added with a fairly mature stage of the US economic cycle.

• Against the Malaysian ringgit (MYR), we expect the GBP to exhibit a strengthening mode. We believe it is due to the expected continued rate hike in 2018 and 2019 by the Bank of England. In the case of Malaysia, the monetary tightening is coming to a mature stage with the policy rate envisaged to normalise at 3.50%, providing another 25bps upside.

• While we project a stronger GBP/USD in 2018 and 2019, we expect the currency to experience volatility along the path driven by noises. Besides, we envisage the US bond yields rising rather than falling partly due to a tightening monetary policy, which offsets some of the need for the USD to depreciate

Source: AmInvest Research - 11 Apr 2018