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Brexit Keeps the Pound on Its Toes

By Constantin Bolz and Daniel Trum

Slightly over a year after the Brexit referendum, the British pound remains torn between two opposing forces.

On the one hand, some members of the Bank of England (BoE) have signaled that monetary policy could become tighter. On the other hand, concerns about potential Brexit consequences are still very much present. In our view, this should keep the pound range-bound around $1.32 over the next six months.

Judging from economic data, the UK economy is still coping relatively well with Brexit. So we would not rule out the chances of a BoE rate hike this year. Inflation has indeed risen significantly with the weaker pound, and the BoE has voiced limited patience with further increases. This should provide support for a pound-dollar exchange rate in the higher 1.20s.

The risk, however, is that EU-UK negotiations deliver setbacks to sterling from time to time. We thus expect the pound to be more volatile than other currencies.

Politics are not easy on the US side, either. The upcoming 2018 budget negotiations once again raise the specter of a government shutdown. This risk alone should be enough to weaken the dollar further. But there are other reasons for a depreciating greenback, too.

Despite its recent fall, the currency remains relatively expensive. And the Federal Reserve is committed to a very gradual policy of rate hikes. A sudden change in that approach could pull the pound-dollar exchange rate lower again, but this seems unlikely, given weak US inflation data of late.

As Brexit still weighs more heavily, we expect the pound to have only a little upside against the dollar.