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Pound to Euro: Sterling Overvalued by 18% According to New S.E.B Analysis

The pound sterling to euro exchange rate (GBPEUR) may be over-priced according to a new analysis, but near-term gains are still possible.

Pound overvalued against the euro

Those with large outstanding international payments should take note of new research released by analysts at Skandinaviska Enskilda Banken (SEB), the Swedish bank.

SEB have told clients they see sterling nearing its peak against a host of major currencies based on a key analytical approach that takes into account valuations.

Analyst Richard Falkenhall has said he sees the GBP taking its final steps higher as the currency has reached stretched levels against several currencies in real trade weighted terms.

"Despite some additional upside potential in GBP in coming months, most measures of sterling's long-term valuation indicate it is now overvalued," says Falkenhall.

However, the analyst does concede that the situation is "somewhat mixed" with different valuation measures providing slightly different outcomes.

Importantly though, "according to the SEB long-term fair value model the GBP is currently around 5% overvalued compared to its long-term fair value in trade weighted terms, which is far from extreme."

In addition, the Swedish bank argues that sterling is now trading around historical levels in nominal terms after having been significantly undervalued since its depreciation during the financial crisis.

"Among those currencies that in nominal terms appear cheap against the GBP we find both the euro and krona," says Falkenhall.

The euro to pound sterling exchange rate (EURGBP) is assessed as being one standard deviation below its trend adjusted average i.e around levels where EUR/GBP traded prior to the financial crisis.

For the GBP/SEK exchange rate the situation is similar.

"Although the GBP could potentially strengthen somewhat further in coming months, these levels at least indicate that sterling is beginning to look expensive against some currencies," suggests the SEB analyst.

Latest Pound/Euro Exchange Rates

United-Kingdom European-sUnion
Live:

1.1105▼ -0.13%

12 Month Best:

1.208

*Your Bank's Retail Rate

 

1.0727 - 1.0772

**Independent Specialist

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Overvalued in Real Terms, Could Signal the End of Sterling Strength

SEB have argued it is appropriate to view the GBP in real trade weighted terms as it more accurately reflects UK competitiveness.

Using relative CPI inflation as a deflator the GBP appears almost 1.5 standard deviations above its historical average since 1980.

"This is close to historical highs and provides a strong indication that UK competitiveness has deteriorated substantially in recent years, partly because of nominal appreciation.

"Sterling is apparently overvalued by approximately 18%, according to our calculations," argue SEB.

Pound overvalued on an historical basis

But, There is Still Near-Term Support for the British Pound

While the pound could be considered overvalued it must be remembered that currencies can remain either side of fair value for protracted periods of time.

With a looming interest rate rise at the Bank of England the pound sterling could ultimately find current levels maintained.

The GBP is particularly exposed to the euro when it comes to interest rate expectations.

When the probability of an interest rate rise decreases the pound to euro exchange rate falls accordingly.

"Once again, this clearly shows that the outlook for sterling is closely related to expectations of a tighter policy from the BoE," says Falkenhall.

SEB forecast the BoE to embark on its first interest rate rise in February 2016.

"Considering the relationship between monetary policy expectations and the GBP this should trigger further support for sterling in coming months, which is mainly why we maintain a positive view on the currency at present levels," says Falkenhall.

The EUR to GBP exchange rate is forecast to fall below 0.70 over coming months and back above the 13 level against the krona.

"However, this is likely to be the last leg for the strong GBP as the currency has reached levels at which historically it has been viewed as expensive," says Falkenhall.

Technical Barrier Could Halt Euro Strength

Looking at the charts we note the euro is struggling to make any fresh advances from a technical perspective.

"EUR/GBP is consolidating after breaking hourly resistance at 0.7422 (24/08/2015 low). Hourly support lies at 0.7196 (22/09/2015 low). Expected bullish move before entering into another downside move," says Yann Quellen at Swissquote Bank in Gland, Switzerland.

In the long-term, Quellen notes that the exchange rate remain caught in a technical downtrend. "The general oversold conditions suggest a limited medium-term downside potential. A key resistance lies at 0.7592 (03/02/2015 high)," says the analyst.

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