Sterling should be treated like an emerging markets currency: analysts

Sterling should be treated like an emerging markets currency: analysts

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The British pound is behaving like an emerging markets currency due to Brexit and liquidity conditions, Bank of America analysts claim.

In a note this week, Kamal Sharma and Myria Kyriacou, analysts at the bank, warned that the U.K.’s departure from the European Union would permanently change sentiment around sterling.

“Using turnover statistics from the BIS Triennial Survey alone one would conclude that the depth of the GBP market should have provided some cover against volatile market moves,” they said. “This has not been the case and, in our view, Brexit is likely to permanently alter the way in which investors view the pound.”

The BIS Triennial Survey, conducted every three years by the Bank for International Settlements — an organization owned by 62 central banks — analyzes the size and structure of global foreign exchange markets.

Sterling was trading 0.2% higher on Thursday at around $1.2444. It has suffered volatile swings in value since the U.K. voted to leave the European Union in June 2016, peaking at $1.4335 in April 2018.

The BofA note’s authors attributed the change in the currency’s position to a breakdown in liquidity conditions since the Brexit referendum. Trading conditions would continue to deteriorate into the end of this year, they speculated, with liquidity risks remaining high as the end of the Brexit transition period — scheduled for December 31 — loomed.

Because of this, they noted, investor analysis of sterling could not be carried out within the framework of traditional G-10 currencies. Liquidity conditions were instead pushing the pound toward price action more closely associated with emerging markets (EM) currencies.

“A more bespoke view of the pound is required and one that would take an EM-esque view, particularly as the U.K.’s internal and external debt dynamics morph into comparisons with some of the more developed EM nations,” the note’s authors said.

They added that headwinds were building up against the pound, which led them to believe that “traditional valuation metrics vastly overexaggerate the degree of GBP undervaluation.”

A bias remained for a weaker pound versus the euro, Japanese yen and Swiss franc, the note said.

Risk-on currency

Speaking to CNBC’s “Squawk Box Europe” in March, David Bloom, global head of FX research at HSBC, compared sterling to currencies linked to risk, such as the Norwegian krone and the Australian dollar.

“Sterling has moved into a risk-on currency,” he said. “Why? Because we wanted to be global, we didn’t want to be part of the European Union, we didn’t want to be part of the big closed economy, we wanted to be an open economy. And now we are, our currency trades like a medium-sized open economy, so it does swing around very violently.”

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