British Pound Back Above 1.15 Against the Euro as Brexit-Lite and Even Bremain are Discussed

Pound Sterling trades higher thanks to signs of growing inflationary data but the outlook will ultimately be settled by actions at the Bank of England and by those politicians negotiating our future relationship with Europe.

• Prospect of Brexit-Lite option seen as emerging positive for GBP outlook
• But, Morgan Stanley confirm they are looking to bet on further GBP downside as another big interest rate cut is coming
• Pound to Euro exchange rate trades at 1.1571, 24 hour best = 1.1588
• The Euro to Pound Sterling exchange rate is at 0.8641, 24 hour best = 0.8725

The British Pound is back above the recent lows recorded against both the Dollar and Euro in mid-week trade. 

One of the triggers to the recovery has been the news that UK inflation is ticking up at a faster-than-anticipated rate.

Headline CPI (Annual) rose to 0.6% in July, ahead of the 0.5% forecast.

This suggests that inflation could be rising at a faster rate than those at the Bank of England would be comfortable with; this in turn suggests the Bank will have to think twice about implementing further GBP-negative policies in the future.

"The recent recovery of oil prices combined with mounting downward pressure on sterling means the pickup in UK inflation is going to be sharper than on our previous forecasts, even if signs of the pickup are still mixed in today’s first official post-referendum data," say Lloyds Bank in a note to clients following the release of the price data.

However, it was the acceleration in factory costs (the Producers Price Index, or PPI) that really raised eyebrows. Monthly PPI rocketed by 3.3%, well ahead of the expected 1.7% rise.

This tells us that the cost of manufacturing the goods we buy on the shop floor have risen markedly and traders are anticipating this to be reflected in our shopping baskets withing months.

For Sterling, whether the Bank of England acts on rates and quantitative easing again in 2016 is a central question, and based on the latest inflation data we have seen the answer would be no.

This is a GBP-positive outcome.

Latest Pound/Euro Exchange Rates

	Live: 1.1451▲ + 0.07% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1062 - 1.1107
**Independent Specialist	1.1291 - 1.1336 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Is Bremain Back in Contention?

The real driving force behind GBP at present are the hefty asset purchases being conducted by the Bank of England in the Gilt markets. 

These are in turn a function of expectations for declining UK economic activity based on the deterioration in confidence and an increase in uncertainty since the Brexit vote.

We have noted some decent attempts to remove the uncertainty that the Brexit vote has introduced with Chancellor Hammond stepping forward to guarantee all European Union funding for agriculture and research.

However, these actions are not nearly enough and the longer the process to exit Europe takes, the longer the period of uncertainty lasts.

“Fears are increasing that the UK's separation from the EU may take quite a bit longer than anticipated. Indeed, insiders now claim that the UK is not ready for the negotiating stage of the exit and as a result Theresa May may postpone invoking the formal procedure, which was until now largely expected to happen in January 2017,” notes analyst Yann Quelenn at Swissquote Bank, in Gland, Switzerland.

As it currently stands, formal exit proceedings may only begin at the end of next year and last until Q4 2019.

It is pointed out that the history of the EU is one in which democratic decisions are often overlooked - as was the case with the Lisbon Treaty in France in 2005, or in Greece last year with the OXO vote.

“Currency-wise, we will soon see markets beginning to price in a likelihood of a Bremain, pushing the GBP/USD higher,” notes Quelenn.

This is an interesting view, and one that is certainly not part of the mainstream analyst thought process at present.

While the prospect of the UK remaining in the Union seems highly unlikely based on what we have heard from all mainstream politicians so far, what is up for debate is a so called Brexit-lite scenario.

This would presumably see the UK adopt similar arrangements to those made by Switzerland and Norway whereby they maintain access to the single market via notable concessions on sovereignty.

Freedom of movement is one notable concession the two nations have made.

“The presence of Theresa May at the helm – who campaigned for the UK to remain in the EU – might point to the likelihood of some form of “Brexit-lite” in which the UK retains at least some access to the single market,” say Capital Economics, in a briefing to clients.

Capital Economics agree that much will hinge on what concession the UK’s European partners are prepared to make in light of the already rising anti-EU sentiment in some other countries.

"We Remain GBP-bearish" - Morgan Stanley

The outlook facing Sterling is certainly a complex one, particularly when the moving parts of politics are inputed.

However, we believe that ultimately watching the economic data releases is the best guage for what the future holds.

Recall I said the Bank of England's actions were the main driver of GBP weakness?

Economists at Morgan Stanley have this week warned clients to expect another big interest rate cut at the Bank of England in 2016. 

Morgan Stanley argue the BoE’s economic growth forecasts are too optimistic, and this dovish stance by Morgan Stanley's economists supports their expectations of a second easing package to be announced in November.

Economists are calling for another 15bp cut, which is larger than market's current pricing of 10bp, suggesting there is room for further GBP weakness.

GBP real rates and yields have also fallen to negative levels, making it unattractive in the current yield-seeking environment.

"We remain GBP-bearish and like selling against EUR and USD which we hold in our portfolio," says a note from Morgan Stanley.

Beware the One-Way Trade

One thing GBP-watchers should be wary of is the over-crowded nature of the GBP trade.

Short-Sterling positions, i.e contracts taken out against the currency, are at record highs with traders continuing to pile up bets against the UK currency.

Short positions are now shown to be at a record level having been building for six consecutive weeks now.

The net short GBP position stands at a notable $7.3BN, sellers now outnumber buyers by a ratio of 3.5:1.

Any upside surprise in the UK data docket - which is a thick one this week - "could squeeze the currency quickly higher," notes Kathy Lien, a Director at BK Asset Management.

BK Asset Management are confident that the labour data will be soft but the surprise increase in the BRC retail sales monitor suggests that discounting may have fueled stronger demand in July. 

The recent rally on the back of the stronger-than-forecast inflation data could actually be the initial trigger to a reversal.

Such reversals are however usually quite powerful, and as the move higher in GBP has been constrained so far we would suggest another trigger will need to be pulled.

"So while the trend in GBP is still down, selling Pounds may not be an easy one-way trade," says Lien.

Technical Studies Advocate for Further GBP Losses

While Swissquotes Quelenn does introduce the idea of a Bremain posing notable upside risks to the Pound from a fundamental perspective, for now he continues to advocate for further declines in the GBP/EUR rate.

Support for the pair at the 1.1592 low (recorded on 06/07/2016) has been broken.

A strong hourly resistance to any upside attempts is seen at 1.1977 which is the 04/08/2016 high.

Quelenn says he expects to see continued selling pressures, while in the long-term, the pair is currently retracing from recent highs made in 2015.

The technical structure suggests a growing downside momentum.

The pair is trading far below its 200 DMA but strong support can be found at 1.1344 (the 25/02/2013 low).