Pound slides against dollar, UK car sales suffer and Hammond’s war chest ‘shrinks’ – as it happened – The Guardian
Although sterling has fallen sharply against the dollar over the past fortnight or so, we forecast that the exchange rate will end this year and next at $1.35/£, above its level now of $1.31/£.
Sterling’s drop on Thursday appears to have been prompted by unexpectedly-weak car sales in the UK..and growing doubts over PM Theresa May’s future. The economy as a whole seems to be holding up quite well, though. And we don’t expect it to be derailed by political uncertainty unless we end up with a new prime minister with a markedly-different view of how Brexit negotiations should proceed.
That risk aside, sterling’s exchange rate against the dollar will probably continue to be driven by shifting views of monetary policy. Expected interest rates shot up in the UK in mid-September after the MPC signalled that it might raise Bank Rate sooner than investors had expected. But expected interest rates then rose further in the US after the FOMC’s meeting later in the month, when participants’ projections suggested that a hike in the federal funds rate in December remains on the cards.
This helps to explain why a fall of more than 2% in the dollar against sterling between these two policy meetings has since been more than unwound. Other “majors” have still fared worse than sterling against the US currency since the MPC’s last meeting, though.
We think that the contrast between policy rates in the US and UK at the end of next year will be a bit starker than investors appear to be anticipating. Our view is that the gap will be minus 1.00-1.25 percentage points (pp), which reflects forecasts of 2.25%-2.50% for the US and 1.25% for the UK.
The gap implied by our forecasts for policy rates would be broadly consistent, on the basis of past form, with a slightly weaker dollar/sterling exchange rate than the one that we are projecting. But the difference is not large. And we suspect that the exchange rate will find some support late next year from the prospects for monetary policy in 2019. We forecast that the gap in policy rates will shrink to minus 0.75-1.00pp during that year, as the Fed’s tightening cycle ends in the spring while the MPC’s continues gradually.