Pound Reaches New Milestone Against Euro in Impressive Recovery; 1.17 Breached as EZ GDP Data Unable to Halt GBP/EUR Rally

The fresh impetus behind the UK currency is well discussed in our live coverage section here.

Be warned that the British Pound is looking overvalued at these levels

The question is whether the GBP/EUR can continue its rally, is 1.2 possible?

We see absolutely no reason why GBP/EUR cannot achieve 1.2, but we would caution that such an achievement would only occur by year end.

The rally will surely run out of steam.

Stephen Gallo at BMO Capital Markets warns that the valuation on sterling is looking rich at present:

"The rather subdued reading on July inflation (particularly at the core) is in our opinion the key component of UK data so far this week, whilst the tone of the August MPC minutes essentially cements the signals emanating from domestic price pressures.  

"Had headline CPI in July been in a 3.0%-3.3% range we think the long GBP trade would have been more compelling, but levels below 0.8550 in EUR/GBP for the reasons mentioned last week and today don’t appear to be good value to us in terms of buying GBP.  

"After all, we’re already less than a full point away from the pre-July BoE statement level in the pair."

(Below: GBP/EUR rally hits 1.17, consolidation time?).

Eurozone: Improving, but only slightly

Turning to the Euro we note with interest that foreign currency markets have largely ignored today's good news on the GDP front.

ING Investment Management’s Senior Economist, Willem Verhagen, gives his views on today's Eurozone GDP:

“While direction of the EMU has changed for the better, it is important to remark that in level terms its performance is still pretty dismal as output is still below the pre-crisis peak, a point which the US already surpassed in early 2011.

"The difference between these economies can be explained by the fact that the Eurozone had to endure a much bigger fiscal drag as well as tighter financial conditions and credit supply as a result of the euro crisis.

"Hence, growth is in a sense improving because there are less negative factors at play, which is probably not sufficient to get growth to a sustainable above potential rate.

"What is really needed for that to happen is for consumers and businesses to actively attempt to decrease their savings.

"This is very much a function of a complex interplay between confidence, balance sheet constraints, credit availability and borrowing costs. In this respect, the picture is very diverse across sectors and regions and progress is being made slowly.

"For instance, there are signs that credit demand and supply momentum are slightly improving while peripheral borrowing costs have finally started to come down.

"Nevertheless, from an overall perspective the situation is probably still such that a self-sustaining above potential momentum will remain elusive for the foreseeable future.

Our Conclusion: The British Pound has further upside potential as currency markets continue to lend more weight to relative economic performance. The UK economy is well ahead of that of the Eurozone in terms of recovering from the crisis. However, GBP/EUR is looking a bit rich at current levels and a correction lower is surely due.