The pound’s fall to a two-year low against the dollar could be the start of a no-deal Brexit inspired wave of selling that would push sterling towards a one-for-one exchange rate against the US currency, a leading investment bank has warned.
Morgan Stanley said the nervousness in financial markets over the hardline approach adopted by both Boris Johnson and Jeremy Hunt risked pushing the pound down from its current level of $1.24 to the lowest level since it almost reached parity in the mid-1980s.
“The pound has come under intense selling pressure since Prime Minister May withdrew from her party leadership position, leaving markets with increased concern that the UK may be heading towards a harder Brexit,” the bank said in a research note.
“Should this scenario materialise, pound-dollar could fall into the $1.00-$1.10 range.”
Morgan Stanley said that before Theresa May announced she was stepping down markets had envisaged a soft Brexit – along with access to the single market – or even a second referendum. “Markets have adjusted these probabilities sharply lower,” the note added.
Selling pressure on sterling has intensified since both Johnson and Hunt said the Northern Ireland backstop – designed to keep an open border with the Republic of Ireland – was dead.
The pound hit $1.2382 against the dollar at one point in London trading before climbing back later in the day. Ahead of the peak holiday season, sterling’s exchange rate against the euro touched a six-month low of €1.1075.
Morgan Stanley said a tough negotiating stance adopted by the new prime minister and met with scepticism from the EU would see the pound trade in a $1.10-1.20 range.
“Should the new PM adopt a moderate negotiation stance, we expect the pound-dollar to trade within its current range with $1.20 as the lower end of the range. Should the new PM strike a deal with the EU and bring it through parliament, the pound may rally. The stance of the Labour party will be important for the pound’s valuation too. Should the Labour leadership move closer to a pro-EU approach, the pound may reach $1.35.”
Sterling has already lost 1% against the euro this month and more than 2% against the dollar, putting it on track for its biggest monthly drop since June 2018. With the pound already the worst-performing major currency against the dollar this year, Morgan Stanley were not alone in predicting further falls.
HSBC strategists said a no-deal outcome would push the pound all the way to $1.10, while Neil Mellor, currency strategist at BNY Mellon raised the prospect of it hitting the post EU-referendum low of $1.15 reached briefly during the flash crash of October 2016.
“Clearly the issues facing the UK currently have not been faced in the last decade or so, even during the global financial crisis, and the potential for the pound to hit the 2016 lows is there,” Mellor said.
Sterling’s weakness in the currency markets has been exacerbated by the strength of the dollar, which Donald Trump has said puts US exporters at a disadvantage.
In a finding likely to be seized upon by the US president, the International Monetary Fund said the US currency was 6-12% too high while the euro was 18% undervalued for Germany. The IMF’s chief economist, Gita Gopinath, said Germany was running an excessive current account deficit.