Pound Sterling Forecast Lower Against Euro on 3-Month Timeframe, Julius Baer Says

Image © Adobe Images

Pound sterling is seen lower in the next three months, although economists at Julius Baer say the downside will be protected by the UK's ongoing interest rate advantage.

In a new monthly foreign exchange research note to clients, economists at the Swiss private bank say the currency's outlook is defined by a tension between supportive rate dynamics and rising political risk; interest rate "appeal meets vulnerability."

The bank maintains a "Bearish" view on sterling, while keeping a "Neutral" strategic stance, reflecting near-term fragility against a more balanced longer-term outlook.

At the core of that vulnerability is politics and fiscal risk. Julius Baer warns that "sensitivity to fiscal risks and political uncertainty can weigh on sentiment," a dynamic that has returned to the fore following recent political developments.

Political uncertainty has risen amid declining support for the Labour Party and a loss in a sensitive by-election, with May’s local elections now shaping up as a key test that could trigger a leadership change at Ten Downing Street.

At the same time, structural concerns remain firmly in place.

"Fiscal risks, with national debt set to rise to new record highs," sit alongside "Brexit-related headwinds (labour scarcity, lower productivity)" that continue to constrain the UK’s long-term growth potential.

However, the pound retains some important supports that should ultimately limit the downside.

Julius Baer notes that sterling’s "appeal endures thanks to a higher carry and lower sensitivity to oil prices than most European peers," a factor that has become more relevant as energy markets remain volatile.

Carry refers to how global investors borrow in low-interest-rate currencies to invest in higher-interest-rate currencies, creating a currency flow that supports the high-interest-rate currency.

That advantage has been reinforced by a shift at the Bank of England: "Higher energy prices provoked a hawkish shift by the BoE, which called off the March rate cut and opened the door to monetary policy tightening," the bank says.

There are also external positives.

The UK benefits from a relatively favourable trade arrangement with the U.S., while a recent agreement with the EU suggests a modest rapprochement that could help limit some of the longer-term drag from Brexit.

Even so, the balance remains finely poised.

Julius Baer flags that "a rising overall tax burden creates economic headwinds," while the political divide continues to widen, with Reform UK gaining traction in polls.

The forecasts reflect this push and pull: GBP/USD is seen rising from 1.33 to 1.35 over three months and to 1.41 over a one-year horizon, while EUR/GBP is expected to hold broadly steady around 0.88.

That gives a GBP/EUR of 1.1363.