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The pound is still a solid bet, says U.S. investment bank JP Morgan.
Pound sterling's pullback against the euro gives investors a better entry into J.P. Morgan's call for further sterling gains, a trade the U.S. investment bank has held through the Bank of England's November rate hike.
"Our conviction in GBP longs has strengthened this week after the hawkish hike from BoE and we maintain our short EUR/GBP position despite broader risk-off sentiment and UK exposure to AI," says a new FX market analysis from the investment bank.
The Bank of England raised Bank Rate to 4.0% on 5 November by an 8-1 vote, a decision that supports J.P. Morgan's call by protecting sterling's yield advantage over the euro.
The pound-to-euro exchange rate rallied 3.5% from late September to a peak of 1.2016 on 30 October and has since made a shallow 0.5% pullback to 1.1957, leaving J.P. Morgan's trade from 0.8514 in EUR/GBP (GBP/EUR 1.1745) 1.8% in profit.
Valuations are nevertheless now a concern for many, and J.P. Morgan's fair value estimate puts EUR/GBP at 0.8460 (GBP/EUR 1.1820).
However, the euro's undervaluation can persist longer, "given supportive UK politics, BoE policy, UK growth and GBP carry, the pair can trade two pence cheap as it did over summer," explains JP Morgan.
"We thought BoE policy movement had been one of the least impactful drivers for GBP this year, and that Q4 could see it become one of the stronger drivers, and this view was bolstered by the decision," says JP Morgan.
Above: GBP/EUR at daily intervals with the RSI in the lower panel. The fall below 70 unwinds technically overbought conditions.
JP Morgan says it is targeting a move in EUR/GBP to the 0.82 handle, which equates to a move in GBP/EUR to 1.22.
Valuation concerns are also front of mind at Crédit Agricole, and strategists at the French bank think a short-term adjustment will occur. They hold a long EUR/GBP trade (a bet on a lower GBP/EUR) that its short-term valuation model, FAST FX, reopened on Monday with a take-profit at 0.8496 (GBP/EUR 1.1770).
The model shows EUR/GBP more than 1.5 standard deviations below fair value, and the bank's separate positioning model flags the pound as overbought against the G10 currencies, which means investors already hold large sterling positions that can be unwound.
From a medium-term perspective, Pound Sterling Live continues to hold a constructive view on the pound's prospects, with the UK economy performing well and the Bank of England still raising rates as UK inflation proves sticky and slow to fall back to the 2.0% target.
Pound sterling needs a daily close above 1.20, the upper end of its post-Brexit range, to resume its rally, with the 1.2016 high the first resistance beyond it.
