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After a roller-coaster ride in 2016, here’s what sterling could do in 2017

It has been a roller-coaster ride for sterling in 2016 as the currency plunged to levels not seen in more than a generation on the back of the U.K.'s vote to leave the European Union but analysts expect the currency to strengthen from current lows as Brexit negotiations start to take shape.

"The long-term outlook for sterling will be heavily influenced by the outcome of the Brexit negotiations," Kallum Pickering, senior UK economist at Berenberg told CNBC via email.

He further explained that Brexit represents a long-term supply-side shock for the U.K. through less trade, migration and investment with the EU.

"A soft outcome for Brexit would mean a less negative long-term impact growth and a stronger long-term rise in sterling."


Sterling 'flash crash'

The currency has seen a lot of volatility since the referendum vote on June 23. While the initial moves were dramatic, plunging from the highs of $1.50 to a 31-year low of $1.32, the pound continues to remain under pressure at current levels of $1.22. The currency is down nearly 17percent since the start of the year and nearly 17 percent down since the referendum day. However, some analysts have said the pound will start to strengthen now.

"The British Pound has been the worst performing G-10 currency this year, reaching a 31-year low. Our analysis shows that GBP will strengthen against the Euro. We expect the worst case scenario is largely priced into GBP, which is at or near its structural nadir," Martin Arnold, director, FX and Macro strategist at ETF Securities told CNBC via email.

Arnold also said that the uncertainty surrounding the referendum and its impact on the pound will slowly fade.

"While we feel the GBP is at its structural nadir, we expect some volatility will accompany the Supreme Court decision. Nonetheless, we expect the Pound to benefit in 2017. The Euro is likely to weaken as the ECB stays its current stimulatory course," Arnold said.


A number of analysts have said that while trade-weighted sterling has appreciated during the past month as economic data has come in strong, the pound is expected to appreciate further as there is more certainty on U.K.'s exit from the EU.

"We expect the rough outline of a post-Brexit deal with the EU to take shape before the German elections in Q4 2017," Stephen Gallo, European head of FX strategy at BMO Financial Group, told CNBC via email. "In order to contain populist uprisings in their own jurisdictions, EU politicians that occupy the center ground will be less able to take an aggressive stance towards the U.K."

Gallo said he expects sterling to fall to $1.21 in the next six months but then climb back up to $1.36 by the end of 2017.

"Political tensions in the euro zone should deflect flows in Europe away from the EUR towards the GBP" Gallo said.

Is monetary policy a driver?

While uncertainty around the actual timing of Brexit and geopolitical events such as the U.S. election and Italian referendum continue to be a big driver for currency movements, speculations around the change in central banks' monetary policy also contributes to the volatility.

ETF Securities' Arnold explained that the currency market will remain dominated by monetary policy changes from central banks across the world.

"Currency volatility will be at the forefront of investors' minds, heightened by ongoing QE policies and political uncertainty. As central bank quantitative easing (QE) policies have kept currency market volatility elevated, the outlook for currencies remains dominated by the global path for monetary policy in 2017."


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