England photoThe primary loser from Brexit is sterling, and it doesn’t look as if the currency is set to recover its losses anytime soon.

With a current account deficit comparable to the size of some small emerging market economies, a political outlook plagued with uncertainty, a dovish central bank and a potential recession on the horizon, sterling is going to be under pressure for the foreseeable future.

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Analysts at HSBC believe that a weaker pound is almost a requirement’ for the UK.

Specifically, analysts believe that GBP must weaken further to help Britain’s rebalancing progress after the decision by the country to leave the EU.

A weaker GBP will help improve the current account 

The key area where a weaker sterling will help the country is in the current account. Traditional economic theory dictates a weaker pound should make UK exports more competitive. Analysts at HSBC aren’t the only ones who have reached this conclusion. The Bank of England’s inflation report, which was published last week along with the bank’s long-awaited new monetary policy measures, claims that the current account deficit is set to narrow to around 5% by early 2017 and is expected to half by 2018 thanks to sterling weakness. The current account deficit was 6.9% of GDP for the first quarter of 2016.

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But HSBC believes that the UK’s current account is unlikely to see any substantial rebalancing unless there is a further substantive and prolonged fall in the value of the pound. The bank believes it is unlikely that any current account trade rebalancing will take place with sterling at its current level.

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What’s more, while economic theory claims that as sterling weakens exports will benefit from a weaker currency, there’s no evidence to back up this assumption. However, in the past countries have been able to improve their trade surpluses following currency weakness but largely through weaker imports. In a low growth world, it is easier to induce a contractionary narrowing of the current account deficit by squeezing imports.

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Initial indications seem to show that UK policymakers aren’t willing to go down this route. The BoE has introduced a range of new monetary policy measures to stimulate growth, and the UK’s new government is expected to loosen fiscal policy at the Autumn Statement in November. These measures are likely to buoy domestic demand and limit current-account rebalancing via the import channel.

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With import rebalancing unlikely, it’s clear to HSBC that for the UK’s current account deficit to fall to more sustainable levels, “a substantive and prolonged fall in GBP will be needed.”

“A country needs capital inflows in order to fund a C/A deficit. To be clear, we are most definitely not arguing that the UK will suffer a true current account crisis. However, the UK’s C/A deficit is now in focus and the market is likely to demand at least some adjustment. It is not plausible that a large enough adjustment will come via the trade channel with GBP at its current level. Therefore, it is clear to us that a substantive and prolonged fall in GBP will be needed. This will also help other, smaller, components of the C/A to cause a material improvement. A much weaker GBP will also have the beneficial effect of making UK assets cheaper to foreign investors and should help to stimulate capital inflows.” — HSBC 

Based on these assumptions, HSBC’s FX team is forecasting GBP/USD at $1.25 by the end of the third quarter and $1.2 by year-end. Furthermore, the team sees cable weakness extending into 2017 and is now forecasting $1.10 by the end of 2017, in line with views that the Bank of England will ease even further over the next six months.