GBP/EUR: Bank Forecasts Failed To Predict The Fall To 1.3000?

Analysts at JPMorgan have taken a scalpel to their GBP forecasts for 2016, joining a lengthening list of leading instutions who were wrong-footed by sterling's recent decline.

GBP/EUR below 1.30 in 2016? Who would have thought!

Clearly not JPMorgan who have had to join an increasingly lengthening list of instiutional analysts at a dinner table for humble pie, after they all missed the steep fall in sterling.  

The scale of the miss is notable if we look at our polls - the average prediction for the end of March period reads at 1.4376, the average June call is 1.44 and the year-end average sits at 1.4204.

The deviation from current rates is now so large we simply don't believe the June forecast average can be attained, let alone the March average.

At the time of writing the pound to euro exchange rate is at 1.2986 on the open markets with international payments being offered as low as 1.26 by some banks. Independent providers are offering in the 1.28-1.2830 area.

The miss by banks is important as it has real-world implications. Watching seasoned forecasters for clues is important for many with international payment needs; “the sharp fall in the value of the Pound against the Euro since the beginning of December has caught a number of corporates off-guard, with many failing to take advantage of the GBP/EUR exchange rate whilst it was above 1.40,” says Andy Scott, economist at HiFX.

HiFX have received a number of calls over the past few weeks from nervous business owners and CFO’s who remain exposed.

“The overwhelming reason given for them not having hedged their risk by purchasing Euros needed in the months ahead through a forward contract for example, was a number of banks forecasts for the Euro to weaken further in 2016,” says Scott.

When Dutch bank ABN Amro called the pound to dollar exchange rate at 1.25 in 2016 we banded it a 'shock' forecast for being so far out of consensus.

But, direction amongst forecasters is moving in such a direction now that ABN Amro could end the year with that coveted reputation as being a forecaster that makes the right calls.

Latest Pound/Euro Exchange Rates

	Live: 1.1456▲ + 0.11% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1066 - 1.1112
**Independent Specialist	1.1296 - 1.1341 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

JPMorgan Slash Their Forecasts

We are seeing others come on board with the 2016 ‘sell sterling’ story. Last week we reported Credit Suisse had cut their British pound forecasts and today we report JPMorgan have done the same.

ABN Amro, Credit Suisse and JPMorgan are all blaming one thing for the underperformance - Brexit. A word you will surely be wary of by the time the year is out.

“By far the most important factor undermining the exchange rate has been an enhanced focus on the UK’s impeding EU referendum. We have been recommending short GBP exposure through cash and options since mid-November as we believed that Brexit risk was underpriced, not only in the spot rate but also in the level of volatility and the skew for GBP puts,” says Paul Meggyesi at JPMorgan in London.

Meggyesi concedes that he and his team have been surprised by the violent manner in which the spot rate and options market have re-priced to take account of the political event risk.

GBP has suffered a dramatic fall from grace since the middle of November - the cumulative 7% drop in the trade-weighted index in fact marks GBP’s worst performance since the tail-end of the financial crisis in late-2009.

Speeding the decline, it is suggested, is talk of the government now favouring a referendum as early as June as opposed to a September or October date which was previously expected.

In the 2016 Outlook Morgan Stanley argued GBP could depreciate by 5-10% should the UK vote to leave the EU due to the economic uncertainty this would create and the disruption to current account financing capital inflows.

Some of JPMorgan’s high-frequency models suggest the risk premium in spot is already close to their best-case estimate of what would happen under Brexit, i.e. GBP is around 5% undervalued compared to a multi-factor regression based on interest rate differential and central bank balance sheets.

“Allowing for the fact the subjective probability of Brexit is around one-third (the odds quoted in the betting markets), this might seem to suggest that sterling has already fallen far enough to discount the probability-weighted outcomes from the referendum,” says Meggyesi.

But - JPMorgan warn sterling can fall further yet if corporate and investor hedging were to continue.

“We would certainly accept that the risk premium in GBP is not trivial, but then again neither is it so excessive to negate the possibility that non-resident hedging flows could well weaken sterling even further in coming months,” says Meggyesi.

JPMorgan estimate that the potential for such outflows is highlighted by the size of the UK’s gross foreign liabilities – at 550% of GDP it would not require foreign investors to hedge much of their GBP exposure for this to generate GBP selling substantially greater than the UK’s current account deficit.

New Forecasts Altered

The pound to euro exchange rate is forecast at 1.2987 in March, 1.28 by June, recovers back to 1.35 in September and December.

Turning the equation around to EUR/GBP, this equates to 0.77 in March, 0.78 in June, 0.74 in September and year-end sees a rate of 0.78.

For the full table, please see here.