Pound Sterling Looks to Extend recovery against Euro into 3rd Day, but UK Currency Forecast to Remain "Depressed" by Leading Analysts

- The Pound bounced for a second day
- Move looks like a technical correction
- Pound was oversold, was due some stabilisation
- Expect strength to be limited
- However UK economic recovery could yet surprise

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The British Pound is looking to post a third consecutive daily gain against the Euro, Dollar and other major currencies on Thursday as foreign exchange markets correct some of the currency's recent losses.

The moves higher by the currency look to be largely technical in nature, indeed we wrote of GBP/EUR on Monday that the daily charts were showing the currency to be oversold and therefore we would have not been surprised to see some consolidation and recovery during the week.

We wrote of GBP/EUR after it hit a fresh 3-month low at the start of the week: "the sell-off officially reached oversold levels, meaning the prospect of a short-term rebound has grown. The Relative Strength Index on the daily chart reached 30: a level of 30 or below signals oversold readings and the RSI typically tends to never back into the 30-70 range meaning either consolidation or a rebound takes place. We would not therefore be surprised to see some short-term Sterling strength at some point this week."

That prediction has played out nicely with the Pound-to-Euro exchange rate paring its losses and pushing back above 1.10 to trade at 1.1087 at the time of writing.

GBP/EUR RSI reaching oversold

Above: GBP/EUR chart on Monday, highlighting the RSI reaching oversold levels (purple line).

RSI recovers

Above: GBP/EUR chart on Thursday, highlighting the correction from oversold in the RSI as a result of the small bounce.

Triggering the recovery from oversold conditions was likely month-end rebalancing moves in global financial markets and significant expiries in the options market. The moves look to have pushed some market participants into booking profits on bets against Sterling, resulting in a recovery that looks to be holding for now.

However, fundamental sentiment and indicators remains negative and pointed towards more downside, therefore we expect any strength to be short-term in duration.

"We expect that the Brexit uncertainty and a sluggish recovery in the last quarter of the year will keep the Pound depressed," says David Alexander Meier at Julius Baer, the Swiss investment bank. "Going forward, we believe that the lasting uncertainties surrounding Brexit will hamper the UK’s recovery out of the coronavirus recession and will continue to weigh on the Pound."

Julius Baer hold a "neutral" three-month target for EUR/GBP at 0.93, or GBP/EUR at 1.0753.

"We maintain a cautious near-term outlook for the GBP in view of the negative growth impact of the Covid-19 pandemic on the UK economy. The prospects for the currency are further made more complicated by persistent Brexit uncertainty and the economy’s weak external position," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

Crédit Agricole's expect the UK and the EU to arrive at a "bare-bones" trade deal for goods by end-2020.

"The GBP is undervalued and oversold, but the weak growth outlook and Brexit uncertainty could keep it close to the lows for most of this year. We have subsequently revised our forecasts for the currency on the downside," says Marinov.

Crédit Agricole say the prospects for the UK economy have deteriorated owing to the twin factors of the covid-19 pandemic and Brexit.

"While both the Johnson government and the BoE have implemented aggressive stimulus measures, the outlook continues to darken," says Marinov who cites an OECD report that shows the UK economy would be one of the hardest hit from the pandemic.

"Persistent economic underperformance could in turn necessitate further fiscal and monetary stimulus before long. While the BoE has so far resisted the idea of negative rates, the UK rates markets are already flirting with sub-zero rates in 9M to 12M. All of that makes us more bearish on the GBP and we have revised our forecasts for the currency on the downside," says Marinov.

Crédit Agricole forecast the GBP/USD exchange rate to trade at 1.26 by the end of September and 1.29 by year-end. The GBP/EUR exchange rate is forecast at 1.11 by the end of September and 1.12 by year-end.

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However, there are signs that some analysts and economists might be overestimating the scale of the UK economic downturn as the Bank of England's Chief Economist Andy Haldane said on Tuesday that so far it appears the shape of the UK's economic recovery is v-shaped.

Haldane told an online forum that "my reading of the evidence is so far, so V," referring to a sharp recovery that follows a sharp fall in economic activity.

"The UK’s recovery is more than two months old, while the global economy is perhaps three months into its
recovery, in both cases from an exceptionally low starting point," said Haldane. "'Fast indicators' used to track the collapse in activity in the first part of this year can also be used to track its recovery."

Bank of England economists now expect consumer spending to be around 20% lower in the second quarter of 2020, relative to the nearly 30% they had officially forecasted in May's Monetary Policy Report. By the end of the second quarter the Bank believes spending is likely to be around 10% lower than at the start of the year.

"Generally speaking, these indicators suggest the recovery in both the UK and global economies has come somewhat sooner, and has been materially faster, than in the MPC’s May MPR scenario – indeed, sooner and faster than any other mainstream macroeconomic forecaster," said Haldane.

If the UK economy starts to put in some positive data surprises we could see one pillar of bearishness to the British Pound start to fall away, which could leave the currency better supported, even if it is not enough to trigger an all-out rally.

Jonathan Haskel, External member of the Monetary Policy Committee, on Wednesday gave an assessment of the economy that chimed with that of Haldane.

"We now expect the second quarter as a whole will not be quite as negative as expected," said Haskel.

One foreign exchange analyst says Haskel's comments might have had a hand in Sterling's outperformance.

"GBP was the best-performing currency after Bank of England Monetary Policy Committee member J. Haskel said the UK economic activity is returning faster than anticipated," says Marshall Gittler, Head of Investment Research at BDSwiss Group. "I guess that’s what passes for good news nowadays."

"His comments were important though because they echo what BoE Chief Economist Haldane said on Tuesday. Haldane is a noted optimist, the one guy who voted against increasing the Asset Purchase Fund at the last meeting because he was confident in the recovery. So it was no surprise that he expressed confidence in the recovery. But if Haskel does too, then that’s a different story. Most of the GBP buying yesterday was vs EUR – this may have been one reason for EUR’s weakness," says Gittler.

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