British Pound to Test 2017 Lows v Euro Again Within 3 Months say Strategists

Strategists at Credit Suisse have taken a conviction line on their forecast for the Pound to fall against the Euro by announcing a trade recommendation that seeks to take advantage of the decline

• Quotes
• Pound to Euro exchange rate today: 1.1861, up 0.65% on the day's opening rate
• Euro to Pound Sterling exchange rate today: 0.8432

Most institutions hold forecasts for currency pairs, but when they announce a trade recommendation it is taken as a sign of high conviction in the call.

Credit Suisse say they are confident in betting that the Pound has reaped as much possible strength as it can against the Euro from Theresa May’s decision to call a June 8 election, and it must come down.

Furthermore, a core conviction at Credit Suisse is the Euro is due to make a concerted move higher over coming months.

Shahab Jalinoos, a research analyst with Credit Suisse in Zurich, says he is concerned that his bank’s existing trade recommendation portfolio does not fully reflect their EUR-bullish stance and hence they are looking to increase exposure to the Euro by betting on a rise in EUR/GBP.

“We buy a 25 July 2017 expiry EUR/GBP call spread, strikes 0.8500 and 0.8800. The trade was entered at 0.8492,” says Jalinoos in a client briefing dated April 26.

This is a technical way of saying ‘we are taking out a bet on a rise in the Euro against the Pound’.

For Pound to Euro watchers the above levels translate as follows: 0.85 = 1.1765 and 0.88 = 1.1364.

“This trade reflects our three-month EUR/GBP 0.8800 forecast,” says Jalinoos. The bottom line? Credit Suisse believe at some point in the next three months the Pound to Euro rate will fall below 1.1364.

If the exchange rate finishes above the 0.88 at expiry, it will generate the trader roughly a 2.25% net return.

Pound Sterling Live have also this week reported that JP Morgan have entered a similar trade to take advantage of EUR/GBP gains. More details of their reasoning and structuring of the trade can be found here.

Why are Credit Suisse Betting on the Euro to Gain Against the Pound?

Credit Suisse have taken the conviction call because as well as wanting to be exposed to the potential for further generalised Euro gains they suspect that the good news for GBP relative to Euro stemming from the 18 April announcement of a UK general election to be held on June 8 is mostly priced now.

Analysts point out a dramatic scale of victory for Theresa May's Conservatives (100+ seat majority) is already expected.

Meanwhile, Credit Suisse economists suspect the UK economy is being dragged weaker by stalled consumer spending and soft investment, just as these indicators are picking up in the Eurozone.

Risks to the Call

The main risks to the trade are:

1. The French second round election outcome sees a surprise Macron defeat, or June 11 and 18 parliamentary elections result in an ungovernable country;

2. UK election results are so strongly in favor of Theresa May and the Conservatives that she quickly feels confident to signal a softer position on Brexit; and

3. Structural positioning is still too short GBP to allow for material losses to be sustained

But we Thought Credit Suisse Were Raising the Pound’s Forecast Profile?

The news that the Swiss bank are entering a bet against Sterling comes a mere week after we reported that Credit Suisse had put clients on notice of an impending upgrade to their GBP profile.

In a note to clients dated April 19 Credit Suisse say they are looking to bump up their forecasts for Sterling following “the latest ‘out of the blue’ event that is Theresa May's decision to call for a UK general election on June 8.”

The move has been well received by GBP, “based on the thesis that the Conservatives are likely to win by a landslide and have a clear mandate to push through Brexit negotiations without too much inconvenient domestic opposition,” say Credit Suisse.

Credit Suisse argue the case for raising their forecasts for the Pound are compelling on the view that being ‘short’ on the Pound has been a structural position in the market and is now an exposed one.

Analysts are waiting for the outcome of the final round of the French election before putting pen to paper on their latest Pound forecasts which we expect to reflect a higher Sterling profile.

It must be pointed out that strategic trade recommendations often differ to certain degrees from the ‘house view’ of a major institution.

Therefore there can be seemingly contradictory research notes as is the case here. The important point to note amongst all this is that the downside potential in Sterling has been drastically reduced.

ECB Gifts the Euro no Favours

The ECB has opted to leave policy settings unchanged at their April policy meeting but the accompanying statement and press conference corresponded with a fall in the Euro against the likes of Sterling and Dollar.

The Bank announced the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively.

In the press appearance following the release ECB President Mario Draghi gave Euro-bulls nothing to bite on and towards the latter part of the conference the Euro came under noted selling pressure as Draghi hammered home the point that there were no plans to withdraw stimulus in the near-future.

"Net asset purchases of 60 bln p/m intended to run until the end of December 2017, or beyond, if necessary," said Draghi.

Draghi notes the Eurozone economic recovery is becoming increasingly solid and downside risks have further diminished.

But, inflation pressures remain subdued and are yet to show a convincing upward trend, particularly core inflation.

No change to the Bank's agenda will be forthcoming until inflation goes higher - and inflation is the bottom line for the the ECB which has no mandate to target economic growth.

"The Euro drops as ECB's Draghi says there is no sufficient evidence to alter inflation outlook, no evidence of self-sustaining inflation mov," says Holger Zschaepitz, Senior Editor of the Financial Desk at Welt.

Volatility in the headline inflation rate means we need to look through volatility argues Draghi referring to that patch of strong inflation we saw earlier in 2017.

In short, further support from the ECB is required to keep inflation sustained, and the Euro doesn't like this.