13th May - Time to buy Short Sterling
16 May 2016
TECHNICALS:
WEEKLY Short Sterling futures continuation chart
The solidity of the bull trend in the Weekly chart is clear: successive highs acting as good support driving the rally higher and higher.
There is not sign of topping out
Daily Short Sterling chart
Short-term, the completed Double Bottom at 99.31 is adding an immediate stimulus to the bulls – suggesting a move up as far as the recent high….
FUNDAMENTALS:
The UK economy, until recently the fastest growing and best performing in the EU and indeed G7, is now cooling noticeably. The main reason behind the slowdown is the uncertainty created by the looming “BREXIT” vote.
Currently the Remain camp holds a small lead over the Leave camp, but the margin is narrow and could go either way given the percentage of voters yet to make their minds up.
Whether or not the UK remains a member of the EU has important implications for the UK economy and monetary policy. If the vote is to leave the Pound is expected to suffer a devaluation of potentially large magnitude; maybe down to parity against the Dollar.
The driving force behind such a move would be a loss of confidence:
The result of such a shock would be a rise in inflation, slower economic growth and perhaps as the Bank of England warned today: recession. The Bank would need to act, but would it hike or cut interest rates? That would depend on the magnitude of the Pounds decline and the anticipated rise of inflation. Clearly if the currency sell off was seen as manageable and inflation a medium term phenomenon, the Bank’s reaction would be to cut rates to shore up the economy.
However, if the worst case scenario materialised, logic would suggest a rate hike to contain inflation and support Sterling, but that could prove counter productive as it would only compound the negative impact on the economy caused by a weak Pound and may result in yet more currency weakness. The outcome then may very well be a rate cut.
But if the vote is to remain what then?
The economy has already cooled and Q1 GDP is set to be weaker than the already weak Q1, although activity is expected to recover in the event of a remain vote as confidence is restored, the loss of momentum won’t be recovered over night and could take two or three quarters.
In today’s quarterly inflation report the Bank of England makes a similar point. But what if the loss of momentum going into the vote is such that activity can only be restored by an easing of monetary policy?
In the event of a vote to stay in the EU the Pound is expected to rally, given the current state of the economy and the already ultra-low level of inflation, that might just be enough to cause the Bank to ease.
We judge the case for a rate cut has significantly increased what ever way the vote goes, obviously the Bank would feel more comfortable about easing if the UK remained in the EU.
So in summary is it time to buy Short Sterling? We think it is.16
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20th May - The Dollar is set to gain strength 
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9th May - The still poised S&P