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Pound Forecast to Reach Parity Against the Euro on Brexit say UBS & HSBC

Should the UK vote to leave the EU in the June referendum the British pound will hit a 1:1 exchange rate against the euro it is argued by two leading financial institutions.

Brexit and forecasts for the euro to pound

UBS and HSBC have, in separate research notes, confirmed they see enough downside potential in sterling for it to hit parity against the euro should the UK exit the European Union.

Rising uncertainty over the UK's place in Europe have weakened sterling in recent months as the probability of Brexit has risen.

Analysts at the bank have told clients that the euro and pound will be on equal footing should the UK vote to leave the European Union, of which analysts believe there is now a 40% chance of happening.

“We have studied where we think EUR/GBP will end the year, depending on the result of the UK referendum on EU membership. We find that EUR/GBP should either move to around 0.73, or to parity, depending on the result of the vote,” says John Wraith, UK Rates Strategist at UBS.

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UBS, like most other institutions, are working off the base assumption that the UK will remain in the EU and have set a baseline forecast for EUR/GBP at 0.73 for the end of 2016.

“However, we expect some further weakness of sterling between now and the vote on 23 June,” says Wraith.

But a vote to leave would push EUR/GBP to 1.00.

“The price action so far makes it clear that sterling would weaken in the event of an exit vote,” says Wraith, “we think that the market would re-price to parity – and to the extent that it could accommodate a shift in the current account by 2.7% of GDP.”

Outlook for the euro in event of a Brexit

An ‘In’ Vote to Shoo in Bank of England Interest Rate Rise, Support GBP

The baseline forecast for 0.73 at the end of 2016 relies on the observation that UK economic data remains firm, and an assumption that the Bank of England will likely bring forward an interest rate rise in the event of the UK staying in Europe.

“If the people of the United Kingdom vote to remain in the EU then, it seems likely that the market would start to anticipate Bank of England rate rises once more and that sterling would strengthen to prior levels,” says Wraith.

The Markets Have Not Fully Priced in Brexit, More Losses Likely

According to UBS, at current levels (0.7851) the pound sterling is still to rich against the euro.

This will come as bad news for those out there who have been holding out for a better exchange rate and have instead received a pummelling.

“Today sterling is probably still a little strong. Opinion polls give us a 40%
chance that the referendum result is for the UK to leave the EU. That should mean EURGBP trading at about 0.84,” says Wraith.

Put another way, the market is now pricing roughly a 25% chance of exit (assuming that the result of the vote is taken as final).

“With the available evidence this seems low to us,” says Wraith.

HSBC Forecast Parity in EUR/GBP

The forecast from UBS comes hot on the heels of a similar call made by the team at HSBC who say the chance of a British exit from the EU are now too high to ignore.

HSBC currently see a one in three chance that the UK votes to leave the EU and the impact on the currency will be where Brexit will be most acutely felt.

The bank have warned that such odds are too significant to ignore and there is a the prospect of a 15-20% slide in the GBP to USD exchange rate in the event of a Brexit.

"We also think that the GBP would come under pressure against the EUR," say HSBC, "indeed, EUR-GBP could move towards parity in the aftermath of a Brexit vote," say HSBC.

BUT

Having read the research from both HSBC and UBS there is one element missing - the potential negative impact on the euro posed by Brexit.

Other commentators are increasingly coming around to the idea that a Brexit will be a big negative to the future structure of the European Union, and this implies downside currency risks.

Barclays have warned in a note that the euro potentially has more to lose on a UK Out vote.

Quantifying the impact on the euro is understandably harder to predict because of the amount of moving pieces in the European Union at present.

Indeed, with the migration crisis shaking European political stability one can see how a British exit could well turn the tremmors into an earthquake.

The only certainty we have at this stage is that 2016 will produce much excitement in foreign exchange markets.

A Boost to Exports? Depends Who You Listen To

News that the euro and pound could be on a level pegging soon should come as sweet news to UK exporters who would enjoy a massive boost as the price of their goods hit record lows on the European market.

Europe still accounts for the majority of the UK’s export demand.

UBS say there is no reason why the weaker currency will not boost UK exports and aid that long-sought rebalancing of the economy:

“This ought to be enough to bring the current account deficit back down from 4.7% of GDP to the 2% which was prevailing until recently.

“An adjustment of 3% would need to come from a 10% relative rise in exports to imports, which in turn should come from a 45% move in EURGBP versus its level prior to the concerns over Brexit.”

However, HSBC don’t see any potential boost to UK exports:

“Sterling would have been driven down by uncertainty surrounding future trade arrangements with the UK’s largest trading partner, which could deter
potential buyers of UK exports within the EU, despite lower prices (in EUR terms).”

HSBC suggest it could be a repeat of 2008, when a large sterling depreciation did little to boost trade.

It is worth noting that HSBC only offer a worst-case scenario in their assessment of Brexit and we are not surprised they swept what will undoubtedly be a positive under the rug.

It does not stand that trade barriers would immediately be raised in the aftermath of a UK exit; and which economically-minded European importer would not rush across the channel to buy discounted goods and services that would surely boost their own bottom line?

Human nature will not change in the wake of Brexit.

ECB Intervention Likely in March, Euro Being Sold

There is also the risk of a concerted policy effort from the ECB at their 10th March meeting and we have seen the euro exchange rate complex come under pressure over recent days as a result of growing expectations for meaningful action.

Markets are increasingly pricing in strong action in the wake of recent inflation numbers on the basis that the ECB is keen to stimulate prices towards their 2% target.

"Friday’s correction on US GDP data was especially significant. The euro area inflation estimate, just released, fell well short of expectations. On the release of data, the euro made its first foray into the 1.08 area. With the ECB meeting due in just over a week, on 10 March, downside pressures should intensify," says Asmara Jamaleh at Intesa Sanpaolo in Milan.

Inflation read at -0.2% for February, down from 1.2% the month before.

German Employment Firms the Euro

Some good news for the shared currency at the start of the new month with data showing unemployment in Germany continued to fall by another 10k in February after a decline of 19k last month.

The unemployment rate remains unchanged at 4.3%. Detailed results for January published today by the German statistical office, Destatis, show that unemployment decreased by 9.4% on the year in January 2016.

This decline was most pronounced for persons between 25 and 75 years (-13% y/y) while youth unemployment (under 25) declined slightly by 1.4% y/y in January.

 

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