Bulls back in for sterling as recession fears fade in the UK

Cautiousness is warranted post-Brexit: Pro

In the space of a couple of months, sterling's post-Brexit referendum slump to 30-year lows has been followed by a rally – and some analysts think that the U.K.'s currency will continue to build its strength.

Banks including Italy's Unicredit are closing their short positions in sterling, sending the currency up 4 percent from its August low. Economists, seeing the rash of positive data on the U.K. economy restoring confidence that a recession is not yet imminent, are rushing to upgrade some of the gloomier forecasts for the 2016-17period.

Manufacturing, services, consumer spending and construction data within the last week all suggested that the U.K. would stave off the recession many economists warned of for a few months at least - especially after the Bank of England stepped in with a ramped-up stimulus program.. Economists at Credit Suisse hiked their forecasts for UK growth in 2017 to 0.5 percent, compared to the previous forecast that the economy would shrink by 1 percent next year, on Tuesday.

British pound coins can be seen next to American Dollar notes.
Christopher Furlong l Getty Images

"Resumed political stability, a weaker currency and the Bank of England's policy response look to have stabilized activity after confidence fell sharply in the wake of the vote," the economists argued.

The post-Brexit garden may look rosier than expected, but many in the City, who almost universally warned about the dangers of post-Brexit recession, are still taking a cautious approach to the sterling rally. Better-than-expected data could also make the Bank of England hold fire on further loosening of monetary policy. While the Bank had been expected to make a further small cut to interest rates in November, the Credit Suisse economists now forecast that is more likely to move in February.

"The data so far (are) not really helping the case for further monetary stimulus," Valentin Marinov, managing director and head of G-10 FX research at Credit Agricole, told CNBC.

There are also concerns about whether investment in the U.K. will continue to grow, after manufacturing trade body EEF, reported that its measure of investment plans for the year fell to its lowest level since late 2010, when the economy was still recovering from the credit crisis.

"Indications on investment have not been so stellar and this suggests that sterling could still be in for a rocky ride," according to currency analysts at Rabobank, who forecast sterling to sink to 1.27 against the dollar over the next six months.

With both Japan and the U.S. sending frosty signals to the U.K. about future trade deals once it has exited the EU at the G20 meeting, there are plenty of reminders of how uncertain the post-Brexit future could be.

"We expect the headwinds to strengthen later this year…cautiousness is warranted," Marinov warned.