Pound-to-Euro Rate Forecasts Lifted at Danske Bank

Above: The Danske Bank trading floor, image © Danske Bank

Analysts at Danske Bank have revised their Euro exchange rate forecasts and found that the British Pound is likely to advance further on the single-currency than had previously been anticipated for 2018.

"Investors’ appetite for GBP and UK assets has improved substantially in 2018 as Brexit negotiations have progressed as expected and as the BoE is expected to continue hiking the Bank Rate," says Thomas Harr, Global Head of FICC Research at Danske Bank, referencing the potential for higher interest rates at the Bank of England.

Global investor money hunts out jurisdictions which promise higher returns, and the prospect of higher yields on UK cash assets should in turn attract inflows of foreign currency which in turn bids up the value of Sterling.

The Scandanvian banking giant believe that while Brexit still remains a key driver for GBP this year, and uncertainty remains high, "the turn in capital flows and FDI flows back into the UK supports the case for additional GBP appreciation over the medium term."

Pound Sterling has enjoyed a strong start to 2018 as the mood-music surrounding Brexit becomes more upbeat and the Bank of England looks to raise interest rates with the currency being the best-performing in the group-of-ten of the world's largest freely traded currencies. The Pound-to-Euro exchange rate has advanced 3% thus far in 2018 to reach the upper 1.15s, which makes a notable break for an exchange rate which has been confined to the 1.11-1.15 range since September 2017.

The move higher in Sterling has prompted a rerating of the exchange rate at many financial institutions, and Danske are advising that they are to raise their six and twelve month forecasts "a bit".

A target of 1.19 is now in place for the six month timeframe, having previously been set at 1.16.

The 12 month target is now at 1.20, having been at 1.19 previously.

In the near term, Danske are concerned that the Pound might be overbought against the Euro somewhat, which could put the brakes on the recent rally as markets recalibrate.

"But a BoE rate hike in May is likely to continue to underpin GBP," says Harr.

The call for a higher Sterling mirrors those seen by other anlysts with some suggesting GBP/EUR is on course for 1.18 over coming weeks, "the fact is that Sterling is gaining ground against most leading currencies," says Bill McNamara, a professional technical analyst who heads up The Technical Trader service.

The Euro is however the largest constituent in the Pound Effective Exchange Rate basket, which is compiled by the Bank of England, and the move higher therefore reflects Sterling's improved fortunes against the single-currency in particular of late.

McNamara says Sterling's latest price action has lifted it to its highest reading in eleven months relative to the Euro and "there is still little in the broader technical picture to suggest that the latest rally is close to running out of steam."

"In fact, the break of resistance at 1.15 or so implies that there is scope for a run back up to around 1.18 before too long," adds the analyst.

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Pound in Retreat on Inflation Data

Achieving Danske's targets have however become that more difficult following the slippage in Sterling seen over the past 24 hours owing to under-par UK economic data prints.

Whether, this is a turning point for Sterling, or whether it offers a great entry point for traders looking to 'buy the dip' remains to be seen.

Whatever the case, the Pound slumped broadly during the morning session Wednesday as markets responded to lower-than-expected UK inflation figures for March, which place a question mark over the probability of another interest rate rise at the Bank of England next month.  

Headline inflation fell to 2.5% during the recent month when markets had expected it to hold steady at the same 2.7% seen in February. This is far beneath the Bank of England forecast for inflation of 2.8% in the first quarter.

Core inflation, which removes volatile food and energy items from the goods basket and so is seen as a more reliable measure of domestically generated inflation pressures, also posted a surprise fall when it dropped from 2.5% to 2.3%.

We believe this core CPI disappointment could be the true source of Sterling's sell-off from recent multi-month highs against both the Dollar and Euro.

The Office for National Statistics attributes much of the fall to a lesser rise in the prices of clothing and footwear on the high street however, prices of alcohol and tobacco also made a contribution to the fall in the headline measure.

Markets care about inflation because it has implications for interest rates, which are themselves typically a predmoninant driver of exchange rates because of the influence that rising and falling returns can have on international capital and speculative money. After all, it is inflation that central banks are attempting to manipulate when they tinker with interest rates.

"The fall-back in inflation in March probably won’t prevent the MPC from hiking interest rates next month, although it perhaps makes it slightly less likely," says Paul Hollingsworth, senior UK economist at Capital Economics. "The Committee is more focussed on domestic cost pressures, and yesterday’s labour market figures revealed a pick-up in regular (ex bonuses) pay growth."

Judging by the market reaction, Wednesday's numbers may now have placed a question mark over what was a solid consensus that the Bank of England would raise interest rates at its next meeting in May. Perhaps more importantly question markets are now being drawn on further interest rate rises.

"The BoE now has a tough decision to make. Against a global backdrop of higher rates, domestic data is turning over. Sterling is much lower on expectations of the dots pushing out from May this year," says Neil Jones, head of corporates and financial institutions at Mizuho Bank.

Danske's EUR/USD Outlook: Staying Supported 

Concerning the Euro-Dollar exchange rate, analysts see the Euro remaining supported against its trans-Atlantic counterpart

"In our base case of a negotiated outcome of the trade war, EUR/USD should stay supported, and we note that the US dollar increasingly exhibits the properties of a carry currency and thus geopolitical tensions are no longer USD positive," says Harr.

But, short-term, "if the US holds up better than the Eurozone growth- and earnings-wise, then equity flows could weigh on the cross," cautions the analyst.

Danske Bank's medium-term story remains unchanged: a turn in the capital tide from USD to EUR is brewing as the relative attractiveness of EU vs US assets is on the rise.

Alongside valuation, this is set to support EUR/USD over the next 6-12 months we are told.

"A slide within the 1.21-1.26 range could be seen near term but a firm break higher on ECB
will, in our view, constitute the next big move in the pair," says Harr.

Danske have maintained thier forecast profile unchanged and thus continue to see EUR/USD at 1.23 in 3M, 1.25 in 6M, and 1.28 in 12M.