GBP/USD could move to 1.5200 in the case of Remain - ING

Research Team at ING, suggests that under the Remain scenario, they expect GBP/USD to rally by around 4%, with the price action determined by three channels: (1) GBP-specific risk; (2) global risk; (3) re-pricing of the BoE.

Key Quotes

“This suggests there is still value in long GBP/USD positions post referendum, despite the rally seen in recent days. Recent GBP/USD strength has narrowed the Brexit risk premium (from 5% to 2% currently), but has not completely priced it out.

GBP has been performing well over recent sessions as expectations of Brexit have softened. We have largely been assessing GBP’s path by estimating a Brexit risk premium based on where GBP/USD should ‘normally’ be trading according to our Financial Fair Value (FFV) model. While a vote to Remain should see the GBP risk premium quickly disappear, we also think that GBP’s FFV may rise as well. Below we isolate the different factors that contribute to GBP FFV and, based on one set of working assumptions, see GBP/USD trading to 1.52 in the case of a Remain vote.

We see three channels that could determine the scale of the GBP/USD rally in the event of Remain: (1) GBP-specific risk – pricing out of the Brexit risk premium; (2) global risk – improved sentiment leading to higher global equities; (3) re-pricing of the BoE monetary policy outlook.

1) On GBP-specific risk, our estimates suggest that around 2% of Brexit risk premium is currently priced into GBP/USD at this point. We would expect most of the risk premium to be priced out of GBP on the Remain vote. The larger the difference between the Remain and Leave vote (in favour of the Remain camp), the bigger the scope for re-pricing.

2) On the global risk channel, we look at effects of a potential 5% rally in global equity markets. This would have a positive impact on GBP/USD, given the positive beta of the cross to risk.

3) Should the Brexit risk be avoided, the market is very likely to re-price the BoE interest rate outlook (our economists expect the first 25bp rate hike in 1Q17 following a Remain vote). At this point, the OIS curve is actually looking for a 7bp cut over the 6-month horizon. In the case of Remain, this partial rate cut is like to get priced out while some cautious tightening is likely to be priced in. Our rate strategists expect the 2-year UK gilt yield to rise by around 10bp (or a little bit more) in the case of Remain, with any potential rise in UST 2-year yield lagging. Hence, the UK-US rate differential would move in favour of GBP.

We are looking for a GBP/USD rally of around 4% (towards the 1.5200 level, given the current spot) if the UK were to remain in the EU, driven primarily by the fading Brexit risk premium. The global risk channel and the BoE re-pricing channel should have an equally positive impact on GBP, but lower compared to the risk of Brexit being priced out.”