Can sterling hold onto its recent gains?

The continued rally in sterling over the past month or so means that it is now around 10% lower on a trade-weighted basis relative to where it stood on the eve of the EU referendum, rather than the 15% that had been the case when talks of a “hard” Brexit were rife. Indeed, over the past month there have been further signs that the government is leaning towards a soft(ish) form of Brexit, with talks of a possible transitional arrangement, continued budgetary contributions, the promise of a parliamentary vote at the end of the negotiating process, and the publication of a Brexit plan ahead of the triggering of Article 50 which will be scrutinised by parliament. Meanwhile, sterling has also found some support from renewed political uncertainty in Europe following the Italian referendum, and also a rise in interest rate expectations in the UK relative to those in the euro-zone. While we think that sterling will hold onto its recent gains against the euro over the next year or so, we think it is vulnerable to fall back to around $1.20 against the dollar as the Fed tightens monetary policy faster than the markets anticipate, while the Bank of England leaves rates on hold.