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Pound set to wobble on renewed European political turmoil, Nomura says

Declines in the pound sterling could accelerate as political instability in the euro zone increases, potentially hurting the British currency more than the euro, Nomura said in a note on Monday.

"The euro tends to depreciate much less against the pound when the popularity of the anti-establishment parties rises," Nomura said, noting the effects are usually seen against the dollar and the Swiss franc. "This means pound depreciation against the U.S. dollar could accelerate when political instability in the key euro area nations increases."

Nomura pointed to three main euro-centric forces as likely to weigh on the pound ahead: U.K. external deficit financing was set to become more difficult, the British economy could lose momentum and the possibility that EU governments would pursue a "hard Brexit" could become more likely.

Political ructions at home have already taken a bite from the pound.

The U.K.'s June 23 vote to exit the European Union (EU) sent the currency into a nosedive, with sterling falling from as high as $1.5018 before the results to as low as $1.1450 last month. At 3:48 p.m. HK/SIN, the pound was fetching $1.2469.

Several important votes are coming up on the continent, with the emerging possibility that voters in more countries will upend established political norms to express anti-union sentiment.

On December 4, Italy will hold a referendum on reforming its constitution to restructure the legislative process to speed the passage of laws.

A defeat in the referendum for Italy would be perceived as a victory for anti-European sentiment and could lead to social turmoil in other countries that are already facing a strong resistance to changes, with elections across Europe that will take place next year.

The first key factor set to weigh on sterling was that euro-area investors were losing their appetite for U.K. assets, Nomura said.



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"Foreign debt flows into the U.K. have been a major financing source of U.K. current account deficits, and euro area investors are major investors of U.K. debt securities," Nomura noted, adding that those investors became particularly aggressive after the European Central Bank (ECB) began a quantitative easing program which made British yields more attractive.

But higher political risks in the euro area could put the kibosh on those flows, it noted.

"If euro area political risks increase further, higher volatility and wider peripheral spreads are likely, while sustained political uncertainty can hurt economic sentiment as well," it said. "As a result, foreign bond investment by euro area investors can slow, which will make U.K. external deficit financing more difficult," weighing on the sterling.

Bond yields have certainly shifted. In Europe's periphery, Portugal's 10-year bond was yielding as much as 3.864 percent on Tuesday, compared with as little as 3.028 percent in October. Italy's 10-year bond was yielding as much as 2.228 percent in mid-November, compared with as little as 1.111 percent in September. Even German bond yields have become more attractive, with the 10-year yield rising to 0.397 percent in mid-November, from negative levels earlier this year.

That compares with the U.K.'s 10-year gilt yielding 1.402 percent on Tuesday.

A second factor set to weigh on the pound was that euro-area political uncertainty was likely to weigh on the continent's economic growth momentum, Nomura said.

"The U.K. economy likely needs to rely more on foreign demand, both for growth and the rebalancing of the economy, and the euro area is the U.K.'s biggest trading partner," Nomura said. "If the U.K. domestic economy weakens into 2017 owing to uncertainty about the Brexit outlook, euro area political uncertainty could be an additional headwind for the U.K. economy, adding stress in the U.K. financial market."


Finally, Nomura noted that the EU remained unlikely to compromise much on negotiating the terms of Brexit.

The U.K. has said it will prioritize border control over access to Europe's single market, while core EU officials were sticking with a "hard Brexit" stance that immigration control wasn't compatible with free-market access, Nomura noted.

Many of the anti-establishment parties gaining popularity on the continent are euro-skeptic, which was likely to spur incumbent governments to make EU exit as unattractive as possible to discourage further breakup of the union, the note said.

"The 'core' countries are unlikely to see their governments sympathizing with the U.K.'s stance after the 2017 elections owing to anti-establishment support increasing," Nomura said. "This suggests the EU's 'Hard Brexit' stance is likely to continue. Further rises in anti-EU party momentum could keep Brexit stress high."

Spriha Srivastava contributed to this article.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1

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