Pound Selling to End at 1.22 Against the Euro say ING, to Stay at 1.25 for 3 Months say DNB Markets

The British pound to euro exchange rate (GBP/EUR) sell-off can't last forever and we consider a mix of fundamental and technical forecasts to establish where the move lower may end.

• Key technical break below 1.25 support finally takes place on Tuesday the 5th opening the door further declines
• Citi see euro strength waning going forward while ING argue further declines must occur to account fully for Brexit risks
• Pound could stay in region of 1.25 for 3 months suggest DNB Markets

After days of bobbing up and down just above 1.25 the GBP to EUR conversion finally succumbed to an avalanche of selling on Tuesday the 5th. 

This is a significant development from a technical consideration as the level unlocks the door to further GBP weakness. This support zone, that has historically halted moves in the exchange rate, was expected to prompt strong buying interest in the markets when met.

In the event, the resistance put up by the buyers appears to have been inadequate and a capitulation in the exchange rate below 1.25 appears to have occured.

Latest Pound/Euro Exchange Rates

	Live: 1.1444▲ + 0.01% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1055 - 1.1101
**Independent Specialist	1.1284 - 1.133 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

These Falls are Justified But They Won't Last Forever

According to analysis from investment bank I.N.G, these declines must ultimately be delivered as it is justified by the risks surrounding the UK’s mid-year EU referendum.

And, there are further declines ahead for the British pound warns ING’s Petr Krpata in a recent currency forecast update to clients:

“Looking back at how much risk was priced into GBP ahead of the 2014 Scottish referendum, and then the 2015 UK general election, we feel that a larger risk premium is required in GBP crosses now.”

The firming of Brexit risks should keep the pound to euro exchange rate below 1.25 argues Krpata.

However, downside against the euro should ultimately be limited by the observation that the euro is also at risk of a UK exit from the European Union.

“Yet, in addition to the event’s direct impact on GBP, we also think that Brexit risks will eventually weigh on the broader EUR as well,” says Krpara.

Recall that the June 1992 Danish rejection of the Maastricht treaty sparked a material unwinding of EUR convergence trades.

“Brexit would raise serious questions about the direction of politics as we head into French and German elections in 2017. We see 0.82 as the likely upper threshold for EUR/GBP going into the referendum,” says Krpata.

Euro Strength to Wane

Analysts at the world’s largest foreign exchange dealer, Citibank, also suggest that the euro has vulnerabilities.

Citi note that much of the euro’s recent advance actually have US dollar selling to thank (seasonality plus Yellen).

These factors are now seen fading and, “weaker EUR fundamentals should now likely re-assert themselves with ECB purchases of debt under its QE programme set to kick start.”

The start of the next phase of ECB QE should result in a roughly 33% increase over existing flows say Citi which sees them bearish on the EUR going forward.

GBP/EUR Could Stick to 1.25 for Months

Solid UK economic growth and an improving labour market has favoured the GBP since 2013, and these dynamics are likely to return it is argued.

Importantly these dynamics will ultimately demand higher interest rates at the Bank of England in the near-future; the promise of higher rates will ensure sterling demand grows as foreign investors look to take advantage of higher returns.

Analysts at Norway’s largest bank, DNB, warn that they believe the market is under-pricing the timing and pace of Bank of England rate hikes.

“We expect the central bank to start hiking in November. Leading up to this we expect to see interest rate expectations pick up and a stronger GBP leading up to this. However, GBP strength will lower inflation and thereby rate hikes will be very gradual,” says Magne Ostnor at DNB Markets.

The latest Reuters poll of economists see expectations for interest rate rises taking place in early 2017.

DNB do however agree with ING in that they anticipate Brexit risk to dampen appreciation prospects for sterling and forecast the pound to euro exchange rate to trade at 1.25 in the one month to 3 month timeframe.

A recovery towards 1.3513 is however forecast over the 12 month timeframe.