Stay 'long' on the Pound is the message from foreign exchange strategists with Nomura plc - the global financial services giant.

The call comes after Sterling’s multi-week recovery against the Euro ran into trouble in the aftermath of the Bank of England’s decision to raise interest rates by 0.25% at their November 2 policy meeting.

The Pound-to-Euro exchange rate dipped from a high of 1.1405 achieved ahead of the meeting to a record a daily low of 1.1185.

The move will have caught some by surprise as typically when central banks raise interest rates the move would be expected to lend support to a currency but there seems to have been a muddle when it comes to communicating further interest rate rises and the Pound fell.

Above: The Pound / Euro exchange rate's movements since June.

Regardless, for Nomura the assumption is that further interest rate rises are coming down the track and the market will have to soon make peace with this outcome and bid Sterling higher.

“The BoE’s communications were in line with our expectations, but the market reaction was in the wrong way and moved much more than what would make sense to us,” says Bilal Hafeez of Nomura’s Global FX Strategy desk.

Despite the bank warning policy tightening being “gradual” and “limited” – a mantra that the MPC repeated in their November 2 commentary – and removal of the statement pointing to the need to raise rates by more than the market expects, “the Bank’s forecasts for inflation to remain above target for the duration of the forecast horizon continue to suggest to us that interest rates will move up at a faster rate than the exceptionally slow pace implied by market pricing,” says Hafeez.

The markets response to the decision - to sell Pound Sterling - has only strengthened Nomura’s resolve on their pro-Pound call as it merely offers a better risk-reward opportunity.

“As a result, we stick with our view that the Bank will raise rates by 25bp every six months, the next move being at the time of the May 2018 Inflation Report,” says Hafeez.

Nomura maintain a bet for GBP/EUR appreciation as a result, but in the short-term they would not be surprised if weakness took the market back to an exchange rate of 1.11 where any weakness is forecast to fade.

Adopting a similar stance on Sterling valuations as per Bank of England expectations is Nikolaos Sgouropoulos at Barclays who says "the market reaction to the BoE’s hike announcement last week seems to have neglected some of the hawkish messages of the Inflation Report and we would not be surprised to see some short-term rate re-pricing in the coming weeks, supporting GBP."

It would appear that the recovery we have seen thus far this week is partly a reflection of markets remaining on board with the fact that further interest rate rises are necessary. We said at the time of the November 2 rate rise that the market reaction was to "sell the fact" and the subsequent recovery reinforces this view.

Sterling in Holding Pattern, Awaits Fifth Round of Brexit Negotiations

Pound Sterling has entered in an holding pattern against the Euro and Dollar at the time of writing with traders awaiting the outcome of the fifth round of Brexit negotiations.

“The prospect of a deal between EU and UK to settle the Brexit bill is crucial towards moving to the next phase of Brexit talks on transition and trade – that would be supportive of Sterling,” says a note from Citi distributed to their clients.

A report over the weekend from the Times revealed, “European Union negotiators have started drawing up the outlines of a future trade deal with Britain after receiving signals from the UK government it would agree to pay more than €60bn (£53bn) for the Brexit bill”.

“Agreement on a divorce bill is crucial,” say Citi as this would allow talks to move on to the next phase of Brexit talks on transition and trade – “and definite progress here would likely be supportive of Sterling.”

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