The pound has fallen against the euro in the wake of the Bank of England's Super-Thursday. But researchers at ING Bank urge those hoping for a better exchange rate to keep their chins up.
The pound exchange rate complex has exhibited volatility in the run-up to the weekend, despite the Bank of England announcing no change in policy, as widely expected.
GBP/USD and GBP/EUR initially fell below 1.4540 and 1.30, respectively, after MPC member Ian McCafferty, who had previously voted for a rate rise, switched sides and joined the majority.
The Bank cut their forecasts for both inflation and growth while putting out the message that an interest rate rise in 2016 is highly unlikely at this stage.
The GBP to EUR conversion has, as a result, slumped back to the 1.30 support zone; a break below here could open the flood-gates to a fall into the 1.25's.
Good news for UK exporters, bad news for importers, holiday-makers and those buying European properties.
Despite the recent declines it is argued by ING Bank that there are still compelling reasons to expect sterling to rise in February.
If they are right then it is worth getting in touch with your currency provider to tell them to set buy orders on any spikes in the GBP, can you afford to miss out?
Reason 1: Brexit Risks Overstated
As we have moved into 2016 the issue of a potential British exit from the European Union has grown as a negative factor for the currency.
The uncertainty that the vote provides has only been exacerbated by polls showing the UK public is warming to the idea of exiting the political union.
However, recent Brexit developments are proving to be GBP-positive according to ING's Viraj Patel.
“Latest Brexit developments and the release of a draft EU deal means that a small window of opportunity may be open for clients looking to capitalise on a near-term GBP correction,” says Patel.
The ING strategist argues that the current ‘Tusk deal’ will probably be viewed as positive for sterling, especially in the period before the 18-19 Feb EU meeting when the details of the agreement will be decided.
ING are so confident in their forecasting that they have called a short on the EURGBP pair.
Patel says that until the actual details are nailed down GBP is likely to rise off the back of the data as it will be viewed as broadly positive and likely to enable David Cameron to go to the electorate with a better deal for the U.K if it remains within the E.U.
“..newsflow ahead of the event (the EU meeting on the 18-19th Feb) may remain GBP positive. Indeed, both sides are keen to focus the media’s attention on the positive elements of renegotiation talks (ie, stemming the flow of bad news), while today’s progress also shows a clear accordance to deliver a deal that has the best possible chance of seeing the UK vote to remain in the EU.”
Reason 2: the Bank of England
ING expect super Thursday to be benign for the pound, as do a number of other analysts we follow. While the initial reaction to the event has been negative, it is still too early to say whether markets have fully digested the message.
Therefore, the coming days will deliver the final verdict.
It is in comparison with more dovish expectations of what the ECB and the US Fed will do at their next meetings, that ING see pound strength coming from, since the neutrality may place the BOE outlook at the ‘hawkish’ end of the CB policy spectrum.
Reason 3: Diminishing Global Risk
ING argue the EUR/GBP pair is especially sensitive to risk aversion, which benefits the euro side of the pair disproportionately.
Over the past two months we at Pound Sterling Live have often drawn attention to how the GBP/EUR has tracked the fortunes of the FTSE 100. The euro benefits when markets are sold as many of those investments being liquidated were made using borrowed euros.
With Eurozone interest rates at record lows global investors have borrowed substantial amounts of euros to fund higher-yield investments elsewhere. Demand for euros to settle the debts has driven the exchange rate accordingly.
But this could soon ease as ING see a calming of the stormy high-risk environment in February and therefore corresponding support for sterling versus the euro.
For one thing they think it unlikely the same high pyrotechnics will be re-enacted in February simply because its impossible to keep momentum at that level, nor do they see as much risk emanating form China which will be enjoying a Chinese week-long New Year holiday during the month:
“Based on our analysis, the magnitude and persistence of the global equity sell-off in Jan exceeded levels noted during the peak of last summer’s market turmoil, recording the highest monthly figure since May 2012.
“In our view, it is difficult to see a repeat of this feat in Feb, especially given that the week-long Chinese New Year holiday is expected to generate some stability in financial markets.
“Hence, we suspect the risk environment will present less of a near-term headwind for GBP.”
Reason 4: March ECB Meeting will be Euro Negative
After Mario Draghi let the cat out of the bag at the last ECB meeting and suggested the governing council would be “reviewing and reconsidering” its policies at the next meeting in March speculation has been rampant as to what sort of policy tools he and his council members might use to continue easing the economy.
The recent rise in the euro against both the pound and the US dollar will certainly unsettle policy makers at the ECB.
ING say the recent move by the Bank of Japan to ease further may also “add fuel to the fire” to the race for ever-lower interest rates and weaker currencies.
Trading the Euro Lower
Based on their observations ING have suggested the following strategy:
“We now see sufficient reasons for a near-term EUR/GBP correction lower, with scope for a move down towards 0.7370. An indicative spot trade (entry: 0.7605; stop: 0.7680) would generate a 3:1 profit:loss ratio.
“Given the risk of a Draghi disappointment, we would advise clients to close any positions ahead of the 10 Mar ECB meeting.”