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Pound-to-Euro Exchange Rate Forecast to Suffer More Weakness, but Consolidation Expected Near-Term

British Pound outlook

Image © Melinda Nagy, Adobe Stock

- Pound Sterling pausing in downtrend, more weakness likely

- Election of Brexiteer PM likely to weaken Sterling

- 'game-changer' seen in technical setup

The GBP/EUR exchange rate is currently trading at 1.1356, after a tentative recovery from the previous week's 1.1299 lows extends.

The exchange rate has essentially gone sideways since last week when the record selloff seen this May finally found a floor.

Concerning the outlook, the question now is whether this floor will hold.

Robin Wilkin, a cross-asset strategist with Lloyds Bank, says the exchange rate remains "in a holding pattern" above 1.1312/1.13 pivot support and under 1.1390 resistance.

"Divergence in the daily studies warn that a broader consolidation is possible," says Wilkin.

However, analysts at IG - a London-based retail trading provider - say a dominant downtrend will most probably take the exchange rate lower.

However, the move will require a trigger, and for IG analyst Jeremy Naylor the trigger to further losses in Sterling will come once a new conservative leader is announced.

“This is just a little bit of a breather before we see another leg lower for Sterling, especially if we do get that hard Brexiteer as a leader,” says Naylor.

Most of the candidates who have stepped forward in the leadership election are Brexiteers, who will probably increase the likelihood of a 'no deal' Brexit on October 31.

The Pound has been falling over the course of May as the market ramped up its expectations for a 'no deal' outcome and we sense the market is now awaiting the specifics from the leading candidates for further guidance.

“The potential downside for Sterling may not have yet been seen if there is a hard Brexiteer who is the next Prime Minister,” says Naylor. “Pressure seems to be mounting for the Conservative party to find a leader that wants to stay ‘in contact’, at least, with a hard Brexit. That’s not suggesting this would ever be a preferred outcome but certainly a leader wanting to pressure the EU into finding another deal.”

GBP to EUR daily chart

If there is a continuation lower, it will probably target support at 1.10 which is the trendline connecting the lows since the record low achieved after Theresa May said “Brexit means Brexit” at the conservative party conference in October 2016, which suggests considerable open ground lower given the floor of the current range is at 1.1299.

Naylor advises placing a protective stop-loss above the 200-day moving average at 1.1400.

A stop-loss is an order which automatically closes out a trade when it goes in the opposite direction to that which was intended.

By advocating placing it here it suggests he sees this as a key make-or-break level for the pair. A close above 1.1400 could be a game-changer for the pair ushering in a much more bullish environment.

Against the U.S. Dollar, Naylor is also bearish, although to a higher downside target at 1.2570, only about a cent below the current market level of 1.2680.

GBP to USD daily chart

Why Expectations for a Deep Decline in Sterling Might be Misplaced

The next leader of the Conservative Party is likely to be a 'Brexiteer' willing to make the decision to take the UK out of the EU without a deal, however, it may be difficult for such a leader to actually make a 'no deal' Brexit happen.

This is because the overwhelming majority of MPs in Parliament as against a ‘no deal’ Brexit and without their support it will be very tough to deliver.

The government can technically ignore Parliament and forge ahead with a 'no deal' Brexit under a committed leader, as per the findings of the Institute of Government:

"It looks like a near impossible task for MPs to stop a prime minister who is determined to leave the EU without a deal. Parliamentary procedure offers no route, and the only apparent way to blocking no deal – a vote of no confidence – would be a massive gamble for Tory MPs," says Maddy Thimont Jack, an analyst at the Institute for Government.

Any attempt at pursuing a 'no deal' without the backing of MPs would therefore almost certaintly lead to a vote of no-confidence in the government, how 'remainer' Conservatives vote is therefore critical. 

It will require a mere handful of Conservative MPs to vote against their government to collapse it if they are unflinchingly and fundamentally opposed to a 'no deal' Brexit.

“If the new Conservative leader makes it clear they are willing to leave without a deal, there are likely to be sufficient numbers of moderate Conservative MPs who are willing to abstain in a vote of no confidence in the government, as Chancellor Hammond hinted at over the weekend. The GBP is likely to remain volatile for the coming months,” says Nick Smyth, an analyst at BNZ.

The expectation for more weakness in the Pound in the long-term based on the assumption that a 'no deal' is a given may therefore be questionable.

What is probably not as questionable is that volatility beckons.

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