Pound Sterling Hits Three-week Best Against the Euro

- GBP set to record second consecutive weekly advance
- But don't count on gains extending next week
- Brexit trade talks end early again this week

- UK economic recovery has opportunity to catch up with European peers


Above: EU Chief Brexit Negotiator Michel Barnier. EU-UK trade negotiation talks ended earlier than expected again this week. File image. Photographer: Claudio Centonze. © European Union, 2020. Source: EC - Audiovisual Service

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The British Pound has rallied further over the course of the past 24 hours to deliver the best exchange rates of three weeks for those looking to buy euros, but further gains material gains will require the economy to catch up with that of the Eurozone while good news on the Brexit front will also be required.

The Pound had started to look oversold against the Euro heading into July and a recovery rally from oversold conditions was triggered by some relatively upbeat media reports on Brexit trade negotiations, while the fading of the covid-19 crisis in the UK combined with a fresh set of stimulus measures from the Treasury this week appear to have helped.

Following the mid-week Summer Economic Update from the Chancellor of the Exchequer Rishi Sunak where £30BN in additional expenditure was announced, the Pound-to-Euro exchange rate pushed to fresh highs at 1.1178 and will record its second consecutive weekly advance.

"The British Pound climbed to three-week highs as the dust settled on the government’s latest plan to help dig its economy out of the coronavirus-led downturn," says Joe Manimbo, Senior Market Analyst at Western Union.

GBP-EUR weekly chart

Above: Weekly GBP/EUR chart

The government announced this week that it would provide an additional GBP30 billion in support, taking the total UK fiscal response to the coronacrisis to £160BN, or 7.2% GDP, according to Sunak.

This is in addition to the measures taken by the Bank of England to ease the pain, which includes cutting interest rates to 0.10% and boosting its quantitative easing programme by £300BN in 2020 taking the total value of the programme to £745BN.

However, the good news on fiscal and monetary policy might now well be in the price of Sterling and next week will most likely require fresh drivers to push the Pound into a third consecutive weekly advance, and on this front the Brexit trade negotiations due to take place in Brussels will be key.

Negotiations remained snagged on issues concerning fishing rights and what EU rules and regulations the UK will follow under the new trading regime and until these snags are released we don't believe the Pound will fly.

"This week’s discussions confirm that significant divergences remain between Flag of European Union & Flag of United Kingdom. We will continue working with patience, respect & determination," said EU Chief Negotiator Michel Barnier following talks conducted between the to sides in London this week.

Talks ended earlier than expect this week - just as they had done the week prior - which appears to be a curious development given that the EU is fond of hammering home the point that time is short.

"Sterling has been able to recover strongly recently on the back of a more positive economic outlook, but Brexit risks should limit further appreciation potential," says Thu Lan Nguyen, FX & EM Analyst at Commerzbank.

Markets appear to have however opted to not read too much into the talks ending early for two weeks in a row now, as there is no clear steer as to whether it is a positive of negative development in terms of the final outcome: it could be good if landing zones have indeed already been established but it could be bad if the talks are terminated early simply due to another impasse.

There have nevertheless been media reports and hints from Barnier himself that the EU is willing to compromise on the matter of fishing rights while additional reports said a number of 'landing zones' for outstanding sticking points were coming into view.

We would look for any concrete evidence of this when the chief negotiators from both sides brief the media at the end of next week. We would suggest that with markets becoming a little more optimistic any disappointments could see Sterling shed some weight, and quickly too.

"With the Pound testing the upper limits of its range it could see some profit-taking, particularly with Brexit uncertainty remaining elevated," says Manimbo.

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Another consideration for Sterling will be the pace at which the economy can catch up to its peers. The Pound's underperformance through May and June could be partly explained by the economic recovery lagging peers in Europe and across the world.

The Euro has been an outperformer over recent weeks thanks to data that shows the Eurozone's economy is emerging from its economic crisis at a faster pace than had been anticipated by markets.

"The prospects for the Eurozone economy have become more encouraging as COVID-19 case growth continues to stabilize and activity and confidence indicators point to a less severe decline in Q2-2020 than we previously anticipated. High frequency mobility data also suggest that the economy has now recovered about 75-80% of the output from the COVID-19-related decline, which could also be consistent with a faster bounce back in Q3-2020," says Jen Licis, Economic Analyst at Wells Fargo.

Analysts at Danske Bank have assessed high-frequency data to try and gauge which economies are lagging and which economies are leading in the economic recovery.

Their findings show that the UK lags the U.S., Japan and Europe in the recovery, which could help explain why the Pound has been such a laggard, particularly against the Euro, during June.

UK lagging the recovery

Google mobility trends for retail & recreational activities shows activity in the UK is half of what it was before the crisis, which is far lower than all major peers. Electricity demand - a sign of industrial and office space activity - is meanwhile down 20%, far worse than in any other country.

"Google mobility data points to improvements in ‘social life’ in Japan, the US and some European countries but the UK remains far behind. Electricity demand in the UK is still very low," says Rune Thyge Johansen, Assistant Analyst at Danske Bank.

This does however suggest the scope for catchup is sizeable and this could result in short-term UK data outperform over coming weeks, which would allow for Sterling to find further bids. Indeed, the UK has tended to lag the Eurozone in terms of infections, deaths, lockdowns and exit from lockdown.

"The Eurozone began easing strict lockdown measures over a month ago and has even began reopening its borders, as the region made progress in containing the spread of COVID-19," says Licis.

But with the UK economy now opening up - July 04 saw a notable easing of restrictions - the opportunity for the UK to get back to some semblance of normality looks to have arrived. Indeed, we would expect consumers to become increasingly confident now that the medical crisis is fading, with the seven-day rolling death toll now below 100 and new daily infections falling to below 800.

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