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Pound a Sell against Euro: Crédit Agricole

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Market Rates at Publication:
GBP/EUR: 1.1863

Strategists at Crédit Agricole's investment banking unit are looking to sell the pounds and buy euros in anticipation of a reversal in recent fortunes.

In a strategy note out October they say policy divergence between the European Central Bank (ECB) and the Bank of England (BoE) has reached extremes, and could correct in the coming months.

The Pound to Euro exchange rate has this week attained a new 20-month high following a rally that means the post-Covid crisis drop of early 2020 is close to being fully retraced.

The Pound fell to a near-all time low 1.0526 in March 19 as investors took cover amidst the spread of Covid-19, confirming the UK currency's sensitivity to global financial shocks.

But fast forward to October 2021 and an economic recovery has aided Sterling higher.

Pound to Euro rate daily chart

Above: GBP/EUR on a daily timeframes since 2020.

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Gains come amidst heightened expectations that the BoE will raise the Bank Rate by 15 basis points in November.

The ECB meanwhile signals it is to raise rates in 2024.

This divergence in hike expectations is one factor aiding the Pound-Euro rate higher say analysts.

But, Head of G10 Strategy at Crédit Agricole Manuel Oliveri says this divergence trade has reached its limits and some giveback is due.

"We expect the ECB to turn less dovish from here and the BoE to struggle to meet the already very hawkish market expectations," he says.

The strategist says the Euro could prove more resilient than Sterling in the near term given its "superior liquidity" and "greater resilience of the Eurozone domestic economy that is still supported by ample fiscal stimulus".

Pound Sterling's sensitivity to risk aversion - as mentioned already - could also deliver declines, particularly "if the Fed’s QE taper leads to a tantrum in the markets in November," says Oliveri.

Demand from Eurozone corporate entities could also aid the Euro, as Crédit Agricole note a period of very weak corporate buying of the EUR that characterised Q2 and Q3 could be reversing.

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Money markets now show investors are fully priced for a 15 basis point hike from the Bank of England in November, to be followed by subsequent hikes to 1.0% in 2022.

Some analysts say should these expectations retreat the Pound could fall, although others say this might not be the case.

"There is clearly more to GBP than some mechanical fixation on the BoE," says Daragh Maher, Head of Research, Americas at HSBC. "GBP remains mostly insensitive to the continued hawkish drift in UK rate expectations."

"For example, while the spread between UK and US rate expectations for a year’s time has widened by close to 50bp in favour of GBP since the start of September, GBP/USD has largely tracked sideways," he adds.

If the GBP is insensitive to rising rates, why would it be sensitive to fall rates?

Markets have meanwhile drastically pulled forward their expectations for a first hike from the ECB into late 2022, which suggests there has already been some movement underway regarding ECB rate hikes.

However, various ECB board members have firmly pushed back against this expectation this week.

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