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Forecast for British pound to euro exchange rate from Bank of America favours GBP into 2014

Update: Nomura offer aggressive pro-GBP forecast.

Following on from yesterday's Bank of England Inflation Report we note the British pound to euro exchange rate remains on the front foot and is maintaining a rate north of 1.19.

Please keep in mind all quotations here are inter-bank spot rates. Your retail rate will be delivered with a spread being subtracted by your bank at their discretion. This is a competitive market though and the good news is that an independent FX provider will seek to beat your bank's rate, thus delivering up to 5% more FX. Please learn more here.

There was a slip-up following on from today's release of retail sales data at the ONS, however the recovery confirms markets are more comfortable holding GBP at this stage.

The pro-GBP theme is furthered by Bank of America Merrill Lynch who have confirmed to clients that they see further pound euro exchange rate gains as we move into 2014.

According to analyst Nick Bate economic data will remain the key driver for sterling.

But, further positive data surprises will be needed to match the Bank's growth forecasts and at the same time support sterling.

In addition, "the evolution of the labor market will be important in assessing the level of slack in the economy. The BoE revised labor market forecasts despite a relatively benign change in inflation and growth expectations - suggesting a small structural shift in their view of spare capacity," says Bate.

A further improvement would lower capacity expectations (today's data has already pushed in that direction) and would support sterling.

"We remain bearish EUR/GBP, targeting £0.80 by next year. A close to trend UK economy with an improving labor market alongside disinflationary forces in the EZ keeping a dovish ECB should help to drive EUR/GBP lower," says Bate.

Turning the equation around to GBP/EUR this translates into 1.25 by next year.

The forecast echoes similar predictions issued by BK Asset Management, FXWW and Lloyds Bank which all have GBP/EUR pegged above 1.2 going forward.


Keep an eye on the UK's pay packet

The October Bank of England Inflation Report could well prove to be a watermark for sterling.

We heard how the unemployment rate could drop to the 7% threshold set in the forward guidance framework as early as next year.

However, this may still not trigger a pro-sterling interest rate rise. Governor Carney says he wants to see slack in the economy pick up before such an event.

This has seen commentators, and markets, start to focus on growth in wages as wage growth is seen as an indicator slack in the economy is being picked up.

Commenting on the matter Bate says:

"We were struck by several references to real wages during the Q&A (for example, the Governor saying that while stronger consumption has thus far been supported by declining savings, "in order for that to be sustained there has to be a rise in real wages").

"While not a formal part of the guidance framework the market would be well advised to keep a close eye on them, as they could be a very important factor in influencing expectations when unemployment drops close to 7.0%, of whether or not the MPC may then be prepared to sanction and signal modest monetary tightening, or might consider lowering the threshold, prolonging guidance and keeping Bank Rate at its current level for longer."

Also noting the importance of real wages is Stephen Gallo at BMO Capital Markets:

"Even if the unemployment rate falls further at a rather quick pace, our view is that the GBP leg of any GBPUSD strength will experience diminishing marginal returns from here, relative to the aforementioned pace of GBP strength during Q3.  

"All things being equal, as long as nominal wage growth remains very subdued, as it has done, continued downplaying of the fall in unemployment by the BoE will eventually for FX become an implicit pushing back of the first rate hike.  Seeing is believing."

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