Sterling vulnerable to renewed dollar weakness

Sterling has rallied to a six-month high against the US dollar, reflecting relief that the UK is not mired in a period of post-election political negotiations and some slightly less dovish noises from the Monetary Policy Committee. Looking ahead, however, we think that sterling could slip back against the dollar. We continue to think that interest rates could rise at a faster pace in the US than markets currently expect in response to the strong prospects for wage growth there. In addition, sterling is showing some of the hallmarks of over-valuation – the UK’s current account deficit is equal to a whopping 6% or so of GDP and the sterling real effective exchange rate is now back to its pre-crisis level. There is a danger that an EU referendum could cause investors to become more reluctant to acquire UK assets at their present rapid pace, forcing the pound to depreciate.