- Sterling is 19% overvalued, Swiss bank UBS says, making it the most overvalued major currency on earth.
- This is largely down to the UK's "elevated" current account deficit.
- Despite dropping more than 10% since the Brexit vote, sterling could have further to fall, the bank's strategists say.
LONDON — The pound remains the most overvalued of all the world's major currencies on a long-term basis, according to analysis from staff at Swiss banking giant UBS released earlier this month.
UBS' 2018 Markets Outlook, part of its annual Global Macro Strategy note — a monster of over 300 pages in total — argues that when stripping out political concerns around Brexit, the pound remains overvalued by as much as 19% thanks to the UK's substantial current account deficit.
"We employ our recently developed FEER-based model, which is based on the analysis of G10 current account dynamics, as an anchor with which to gauge longer-term directionality," UBS strategists led by Yianos Kontopolous and Themos Fiotakis write.
"We believe GBP remains expensive. Rebalancing dynamics ahead of Brexit risks skew GBP risks largely to the downside, as we will discuss in detail below," they continue.
The chart below shows sterling alongside the other nine so-called G10 currencies, which are the most heavily traded currencies in the world. Sterling remains 5% more overvalued than its closest rival, the Canadian loonie.
Sterling may have crashed by close to 10% against the dollar since the referendum in June 2016, but even that fall cannot mask the fact that Britain's current account deficit is still huge — despite years of attempts by successive Conservative Party led governments to bring it down. That deficit should provide a major drag on sterling's valuation but has not, the UBS team argues.
"Brexit and the UK's external imbalances have been central to our negative view on sterling for a while," they write.
"Our FEER model screens sterling as c. 20% over-valued in TWI terms even after the substantial drop since the Brexit referendum, as the UK current account has yet to correct to more sustainable levels.
"In addition, substantial revisions in the income account included in the Q2 Balance of Payments release imply a larger gap to more sustainable current account levels than previously estimated."
The deficit may pose risks to the pound, but so too does Brexit, UBS makes clear, while noting that of the G10 currencies, the New Zealand dollar is close behind in terms of political risks.
"Brexit negotiations remain inconclusive, with risks to sterling still skewed to the downside due to the UK's vulnerable external position. We remain bearish the pound," UBS' team concludes.
"In New Zealand, proposed policy changes by the new Labour-led government as regards the RBNZ's mandate and immigration are likely to cap NZD upside until further clarity or other policy offsets emerge."
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