- HSBC remain pessimistic on GBP

- Traders guilty of "optimistic frenzy"

- GBP/USD to go back below 1.40

- GBP/EUR could dip below 1.10 before year end

Image © Pound Sterling Live

Market rates at publication: GBP/EUR: 1.1665 | GBP/USD: 1.3927Bank transfer rates: 1.1438 | 1.3705Specialist transfer rates: 1.1580 | 1.3899Get a bank-beating exchange rate quote, hereSet an exchange rate alert, hereThe British Pound's solid performance in 2021 has caught the FX analysis team at HSBC by surprise, but they are unsure the good times will last for the currency.

Indeed, the team lead by Paul Mackel, Global Head of FX Research, remain "the most hardened of GBP pessimists".

In a regular monthly foreign exchange research briefing the UK high-street lender and international banking giant says the Pound's strong performance of late has been driven by a stronger economic recovery and "a move higher in interest rates at the front of the curve". (More on this below).

But, "we remain sceptical that outperformance can continue with expectations so elevated relative to reality," says Mackel.

Using the current Euros football tournament as an analogy for perhaps misplaced confidence by investors, Mackel adds:

"Even as the most hardened of GBP pessimists, it is hard for us to stand in the way of a wave of jubilation that seems to be sweeping the nation."

The Pound is one of 2021's best performing currencies - second only to the Canadian Dollar - having advanced 4.0% against the Euro and 3.35% against the U.S. Dollar.

The outperformance has convinced a good portion of the market to engage in bets that further gains are likely, something Mackel describes as an "optimistic frenzy".

Positioning data from the International Money Market (IMM) reveals that relative to historical levels, Sterling has only seen greater long positioning on a handful of occasions in the last decade.

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HSBC's research reveals that the Pound tends to weaken when IMM positioning is high and has risen.

"We believe caution is warranted," says Mackel. "While 'the trend is your friend' is often a very good adage in financial markets, these levels of positioning do require attention."

HSBC find that a key driver of the Pound - UK interest rates - have now potentially detached from current values in the currency, leaving it at risk of a correction lower.

They find the movement in GBP/USD has been much more aggressive than the movement of GBP front-end interest rates (find out more about these interest rates here).

"Given where GBP is trading relative to what rate market moves are pricing in suggests the currency should already be showing signs of vertigo," says Mackel.

Underpinning HSBC's pessimism towards Sterling is the state of the UK economy; they acknowledge that while it is recovering it will still fail to outperform its peers over the next two years.

It is this lagging of peers that ultimately leaves the Pound in the slow lane.

Headwinds blowing against the economy include Brexit readjustments while the UK's persistent current account deficit (the UK imports more than it exports) is seen as a long-term headwind for the currency.

Another reason regularly cited by foreign exchange analysts for the Pound's strong performance in 2021 is the country's rapid vaccination rate that was expected to allow the country to unlock on a sustainable basis ahead of others.

But the country's vaccination rate has now fallen back behind those of Canada, the U.S., Germany, France and Italy with little signs that it will recover its once admirable position given tight vaccine supplies.

And, the vaccination advantage might count for nought given the UK's delay to fully lift restrictions owing to rising cases of the Delta variant of the Covid virus.

HSBC's research shows that the positive vaccine story has not yet necessarily been reflected in UK economic outperformance, and it is unlikely it ever will.

"This should give some pause for GBP bulls, especially as the UK’s vaccination “edge” starts to slow and others catch up with what is already priced in," says Mackel.

HSBC have raised their forecasts for the Pound, but even still, these estimates reside below current levels in spot.

The Pound-to-Dollar exchange rate is forecast at 1.40 by the end of June 2021, up from 1.34 previously. It is forecast at 1.34 by year end, unchanged on previous forecasts.

By mid-2022 the exchange rate is forecast at 1.34.

The Euro-to-Pound cross is forecast at 0.85 by end June 2021, 0.9179 by year end and 0.88 by mid-2022.

This gives a Pound-to-Euro exchange rate forecast of 1.1764, 1.0894, 1.1363 and 1.1363 respectively.

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