GBP defied the bears once again and bounced off its multi-year lows - Credit Agricole

"GBP defied the bears once again and bounced off its multi-year lows after political uncertainty in the UK started to subside when PM May committed to a vote in Parliament on the Brexit deal. This was seen as reducing the risk of undue delay to the triggering of Article 50 and, potentially, mitigating the threat of an eventual very 'hard Brexit'.

UK data remains fairly resilient as well and, coupled with accelerating inflation, means that the BoE will be firmly on hold for the foreseeable future. UK rates and gilt yields could still regain their pre-Brexit highs as a result. GBP remains one of the most undervalued G10 currencies and the market is still running sizeable shorts.

However, the outlook for GBP should remain challenging regardless. We believe that the UK's economic resilience will falter going forward but that the BoE will not be able to respond, constrained by uncomfortably high inflation. Fiscal stimulus should be limited by the UK's sizeable budget deficit, while the vast current account deficit and falling real gilt yields should keep alive concerns about a potential balance-of-payments crisis as well.

Our updated GBP forecasts reflect this 'tug of war' between FX undervaluation, short market positioning and resilient UK fundamentals on the one hand, and the still challenging economic outlook as well as the looming twin deficits in the UK on the other. We believe that a hard Brexit is largely in the price in the case of GBP/USD and revise our Q1- Q217 forecasts to the upside. At the same time, we now see a more muted recovery over the very long term.

We lower our forecast for EUR/GBP for Q1-Q217 to reflect the growing political risks in the Eurozone and the somewhat reduced political risks in the UK. At the same time, the risk of a hard Brexit has increased in our view, and that could be a supportive factor for the cross over the long term. We subsequently revise our EUR/GBP projections for 2018 to the upside".

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