Will declines in the Sterling continue?

The Pound Sterling has fallen nearly 5% on a trade-weighted basis since its mid-November peaks. Much of the sterling's depreciation can be attributable to the reassessment of monetary policy outlook in the UK relative to its trading partners. Since mid-November, the two-year OIS rate has declined nearly 10bp, as against that in the US and euro-zone, which are little changed.

Soft economic data and the realization that an EU referendum could occur as early as June could be reasons for decline in OIS. But, we do not expect the referendum to have a major impact on the UK economy, even in the event of a vote in favor of leaving the EU. However, uncertainty surrounding the Brexit, combined with fiscal tightening, lower oil prices and soft wage growth raise the case for Bank of England to adopt a more cautious stance in the near term, keeping the GBP subdued. 

"We recently lowered our end-2016 and end-2017 forecasts for Bank Rate from 1.0% to 0.75% and 1.5% to 1.25%, respectively. We continue to believe that monetary policy will be tightened a lot quicker than generally expected in the US. Indeed, we expect the key policy rate differential (US less UK) to be more than 1.0% by end-2016, compared with just 0.10% implied in the markets. This underpins our view that the dollar/sterling exchange rate will fall to $1.40 by end-2016," said Capital Economics in a research note to clients