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From zero to hero? The pound’s journey back above $1.30

The pound is worth over $1.30 for the first time since September, after stronger-than-expected retail sales data helped it back over the line this morning. What is the significance of the level and will it hold?

Was the pound reaching $1.30 expected?

Yes and no. In recent weeks, investors and analysts have grown more convinced that it would break $1.30, underpinned by firmer UK data and helped by weakness in the dollar, which is suffering from Donald Trump’s political problems. Signs of a turnround in the pound’s fortunes have been emerging in the last 4-6 weeks from positioning data, which showed bearish bets on the pound coming off.

But a broader reading of the pound shows just how far away from $1.30 sterling was recently looking. Brexit uncertainty at the start of the year had driven the pound to below $1.20, prompting analysts to predict further declines by the end of the year. At one stage, $1.05 was a common sterling forecast, hence the extreme bearish positions on sterling.

What was the wider catalyst for the pound’s rally?

Theresa May’s decision to hold a snap election. On the last trading day before her announcement, the pound was at $1.25. Her decision caused an immediate jump to 2.7 per cent. To some extent, investors noted, a bigger Conservative majority would free her to negotiate Brexit without the impediment of dissenting MPs seeking to cause trouble. But investors were more enthused about the change in the Brexit timetable that a snap election created. The fear had been that a 2020 election would put her under pressure to negotiate a hasty and unsatisfactory deal by the 2019 deadline imposed by Article 50 conditions. An election now means the next one is postponed until 2022, thereby kicking the Brexit deal down the road and opening up space for a transition deal — something investors favour.

What has kept the pound buoyant?

Expectations of a hawkish Bank of England. Growth and rising inflation around the world are prompting investors to focus attention on policymaking. But UK inflation is rising too fast for wages to keep pace and — if that translates to a household spending squeeze — that will force the BoE to rein in those expectations. Governor Mark Carney certainly wasn’t encouraging any hawkish sentiment at the BoE’s most recent meeting. Still, BNP Paribas thinks the pound is undervalued against the dollar and the euro, and says “the underlying language had hawkish elements”, so risks to BoE pricing remain to the upside.

How significant is this $1.30 level?

The pound is still worth 20 cents below its level on the night of the referendum, so investors shouldn’t get carried away by $1.30. Even so, forex hedging advisers say the move will be welcomed by UK importers. They have struggled to meet budgets since the pound’s devaluation, reluctant to pass on increased costs to customers, frantically trying to renegotiate supply terms and facing hits to profits and margins. The new level gives them some breathing room, enabling them to at least lock in the $1.30 level with short-term hedges.

Technical analysts also expect various stop-loss positions to be triggered at the $1.30 level, which would send the pound higher.

So after $1.30, what’s next? $1.40?

That would be a stretch. Another 10 cent gain for the pound would be in Brexit-positive territory — in other words, the market gaining confidence that a satisfactory deal was nearing. There are plenty of other factors capable of holding back the pound, such as a strong dollar revival, a string of poor UK data and, of course, deteriorating Brexit negotiations. Still, the first of these is looking unlikely, despite probable US rate hikes while global growth would somehow have to bypass the UK for the second scenario to occur. Brexit remains unpredictable, but there are signs that the market has priced this in, so bad Brexit news may not weigh too heavily on sterling.

Investors can find analysts who think it possible for the pound to get to $1.35 by the end of the year but there is a better case to be made around $1.32. In all probability, sterling will hover around $1.30 for a while yet.

Related: Check out our PunkFT on the pound

(Chart: Bloomberg)