Goldman Sachs told clients that the main determinants of sterling have shifted from predominantly UK-driven themes to broader global dynamics as markets absorb a terms-of-trade shock the firm expects to be longer lasting. The bank said this change in drivers alters how investors should view the currency's prospects.
Before the energy-related shock, Goldman Sachs said UK domestic macro developments were central to its view that sterling would underperform within the region. That assessment has evolved as the firm observed a notable positive turn in recent UK data this week, a development it contrasted with a deterioration in the Euro area. The move reversed some of the relative UK data weakness that had been a prominent theme during the prior year.
At an aggregate level, Goldman Sachs said the resilience seen in UK releases has provided support to the currency. However, the firm qualified that view by pointing to caveats and quality concerns attached to many of those UK data prints, suggesting the underlying picture may be less robust than headline numbers imply.
On domestic policy, Goldman Sachs' economists say the Bank of England is unlikely to deliver the material rate-hike premium that markets currently price for this year. That divergence between market expectations and the bank's internal outlook is cited as a domestic factor that complicates sterling's outlook.
Valuation and political considerations also feature in Goldman Sachs' assessment. The firm judges sterling to be significantly overvalued on its structural GSDEER metric. It also notes that periodic bouts of fiscal and political risk premia remain a possibility. While the bank regards sterling's recent imprint from political uncertainty as more tactical than structural, it identifies asymmetric downside risks for the currency leading into the May 7 local elections.
Relative performance across currency crosses is a further dimension to the bank's view. Goldman Sachs says the case for sterling underperformance is clearest versus terms-of-trade beneficiaries - specifically the US dollar and the Australian dollar - rather than in pairs that are more sensitive to UK domestic considerations, such as EUR/GBP. In other words, sterling is more likely to lag against currencies boosted by favourable external terms of trade.
Goldman Sachs adds that sterling should remain highly exposed to any renewed improvement in global risk sentiment. Nevertheless, the bank emphasizes sterling's status as an energy importer and the prevailing mix of UK domestic macro forces, which together tilt the distribution of outcomes toward the negative side.
Key takeaways:
- Global forces now expected to dominate regional factors in setting sterling's course amid a prolonged terms-of-trade shock.
- Recent UK data have shown improvement versus the Euro area, but data quality caveats persist and domestic policy expectations challenge sterling's case.
- Sterling's underperformance is judged more likely versus terms-of-trade beneficiaries such as the US and Australian dollars; EUR/GBP is considered more sensitive to UK domestic factors.
Sectors and market areas impacted: Currency markets, fixed income (through Gilt and UK policy pricing), and equity sectors sensitive to exchange-rate moves and energy costs.