Pound Sterling / Euro Forecast 5% Lower by Soc Gen

The decline in Pound Sterling is unlikely to end until a further 5% in value is shed suggests new research from two of Europe’s largest investment banks, the only question up for debate is the speed of the declines.

The Pound to Euro exchange rate (GBP/EUR) rallied through July and into the August Bank of England meeting, putting behind a one year low at 1.1614 against the Euro in the process. 

Those seeking out a stronger Pound should be aware that the outlook remains biased to the downside and the risks of waiting too long are high.

“As the market gradually recovers from the shock and the flash crash, everything points to the next leg being bearish again,” says a note from Olivier Korber, a strategist at Societe Generale.

The view echoes that held by other major forecasters, such as Morgan Stanley and JP Morgan, all of whom believe the next bout of stimulus from the Bank of England will be responsible for the next move lower.

Societe Generale’s UK economists believes the Bank of England confused the markets since the June referendum, something that may have allowed Sterling to creep higher.

However, the announcement of a strong does of stimulus at the Bank of England's August 4th meeting should trigger the resumption of the move lower.

The Bank cut the basic rate to 0.25% (the new floor) while £60BN worth of quantitative easing has been announced. This is more than market consensus estimates.

Korber notes the GBP/USD has actually tracked the probability of an August cut since the start of the year, including during the Brexit turmoil.

But a stubborn Pound failed to fall below 1.30 USD mark when the rate cut probability jumped to 100%, this suggests the Pound was overvalued heading into the event:

Graph A. Near-term: GBP/USD failed to fall below 1.30 when the rates market fully discounted the August BoE cut
Graph B. Medium term: deteriorated fundamentals make buoyant assets complacent, a threat for Sterling
Source: SG Cross Asset Research/Forex Source: SG Cross Asset Research/Forex

The actual announcement of the monetary policy decision could be the trigger of the next leg of GBP weakness.

Societe Generale’s currency strategists believe there are plenty of reasons for the cable to fall over the medium term.

Korber notes:

“The equity market remains buoyant and this reaction shows that a massive policy response to Brexit is widely expected. This makes disappointment risk pretty elevated.

“Nevertheless, gloomy fundamentals suggest a large dose of complacency, with very concerning UK external balances and a large growth shock looming ahead.

“Risk of policy disappointment and the economic shock will continue to weigh on GBP over the medium-term.”

Latest Pound/Euro Exchange Rates

	Live: 1.1455▲ + 0.1% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1066 - 1.1111
**Independent Specialist	1.1295 - 1.134 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Forecasts: 1.09 Possible

Korber believes both the GBP/USD and GBP/EUR will weaken further and says his team forecast GBP/USD will fall below 1.30 after the summer and below 1.25 in 1Q17.

No targets have been set for the GBP/EUR exchange rate, but Korber does say the devaluation could amount to 5%.

“Only a major change in the balance of fiscal and monetary policy, and/or vastly more clarity about the UK's status in Europe would decrease the risk of another 5%-plus fall vs the USD and EUR,” says Korber.

Meanwhile, Korber's collage at Soc Gen, Stephanie Aymes, notes that the GBP to EUR conversion has fallen below an eight year channel and has embarked on a multi-year decline.

The first target of the decline is located at 1.15/1.1429.

Short-term down strength is expected to be resisted by channel resistance near 1.2347.

Aymes says a move below 1.1765 will confirm resumption in the down-move initially towards 2013 lows of 1.1338 and even to 1.0965.

ING: Sterling's Decline Will be Slow

ING’s Viraj Patel says traders should be prepared for a more “orderly” fall in GBP.

Any GBP downside over 3m is likely to be more orderly and fairly limited argues Patel based on the following observations:

1) EUR/GBP is meaningfully overvalued based on ING's BEER valuation model;

2) The speculative community is already meaningfully short GBP, suggesting finding further downside traction will be limited;

3) Brexit negotiations with the EU are unlikely to gain much traction over the coming months as the UK government will initially be working on its negotiation strategy.

“While we look for more GBP downside against EUR (3m EUR/GBP target: 0.88), we think any weakness will be orderly. To take advantage of this, we propose a EUR/GBP call structure with a reverse knock-out barrier,” says Patel.

The 3 month target in GBP/EUR terms is therefore 1.1363.