Potential 3% Upside in British Pound / Euro Exchange Rate Over Coming Months say Morgan Stanley

Pound Sterling could rise some 3% against the Euro say analysts at Morgan Stanley who have noted recent economic data releases actually leave the UK currency looking undervalued.

• Pound to Euro exchange rate today: 1.1915
• Euro to Pound Sterling exchange rate today: 0.8391

Analysts at some of the world's leading institutional banks have been sent back to their desks to reassess their forecasts for Pound Sterling in light of recent economic developments in the UK.

UK economic data released over the August-September period have been better than economists and markets had expected despite the June EU referendum result.

While the Pound has certainly taken a knock from the vote to leave the EU the impact on the real economy has been mild with the strong August PMI series, released at the start of September, being particularly strong. 

The UK economy will likely avoid recession in the third quarter based on the data we have seen.

This will likely have notable implications for the Bank of England’s policy stance with the prospect of further GBP-negative measures (rate cuts, quantitative easing) being announced in November now looking slim.

“Against this background, the oversold but still yielding GBP may bounce back. In the short term, GBP may well be the best performing G10 currency, especially offering recovery potential against the JPY,” says a recent note from Morgan Stanley.

“Even against the otherwise strong EUR, GBP may gain 3% over the next few months.”

That the Pound to Euro exchange rate (GBP/EUR) will rise is interesting as we have noted Morgan Stanley also hold a pro-EUR bias over the near-term noting the ECB’s ineffectiveness in pushing the Euro lower.

Nevertheless, we also observe in our report that Morgan Stanley are forecasting the Euro to fall longer-term with the currency ended 2017 notably lower against both the US Dollar and Pound.  

The US investment bank joins the UK’s Lloyds Bank in forecasting further advances in GBP/EUR - Lloyds see a modest recovery coming on the back of both their technical and fundamental studies.

Analyst at Barclays also expect a rebound noting that since the Bank of England launched their stimulus programme in August Sterling was trading one standard deviation (10%) below  estimated fair-value.

Latest Pound/Euro Exchange Rates

	Live: 1.146▲ + 0.15% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.107 - 1.1116
**Independent Specialist	1.13 - 1.1345 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

BUT - Brexit Remains a Big Risk to Sterling

The current economic situation risks leaving the impression that Brexit risks were overblown.

But, those with an interest in Sterling should guard against complacency warn Morgan Stanley:

“Despite our short-term-constructive GBP view, we are not complacent about post-Brexit risks,” says the note, “we could go even as far as arguing that the absence of near-term economic weakness may increase long-term GBP risks.”

There are also suggestions from other corners that Sterling's August-September rally is looking old.

"With much of the recent bounce being positioning related, the current rally looks to be an attractive opportunity to be considering shorting the unit if not against USD then on commodity crosses & EUR," says a currency strategy note from Citibank.

A note released by Lars Henriksson, FX Strategist at Handelsbanken, on Wednesday the 7th August shows he thinks the rebound in GBP is now finished as his studies indicate the Pound is now close to fair-value levels.

Longer-term Morgan Stanley cite the following pointers when urging caution:

“First, the UK’s domestic demand strength could push the trade and current account balance further into deficit, increasing foreign funding needs.

“Second, and more important, is the political impact of current economic calmness.”

Indeed, David Davis, the Secretary for negotiating the UK’s exit from the EU, told parliament on Monday the 5th August that, "our economy is robust, the latest data suggest our manufacturing and service industries and consumer confidence are strong."

The worry is that the UK economic data could allow those politicians looking for a 'hard exit' to become more vocal.

A hard-exit would be GBP-negative in our view as it would  likely compromise access to the EU single market.

PM May has so far refused to be drawn into any details with regards to what her vision of Brexit looks like saying the EU referendum did not give any one camp in the Leave campaign the right to impose their vision now that Brexit is a certainty. 

“The problem is that the Tory party’s Brexit camp is now advocating for a hard exit, suggesting that maintaining full EMU market access no longer seems a top priority,” say Morgan Stanley.

Morgan Stanley argue a ‘hard exit’ strategy implemented by the British government would not only weaken the economic outlook, in their view, it would also raise questions about Scotland’s status within the UK.

"All in, a GBP rebound should be limited and reverse later this year," say Morgan Stanley.

The further we move away from the Brexit vote, and Brexit itself, the more complicated the whole issue reveals itself to be.

There are positives - Australia, Singapore, South Korea, India and Mexico have all made positive noises about forging stronger trading relationships with the UK over recent days.

However, these are countered by warnings from the likes of Japan that some of its pharmaceutical companies and banks may have to relocated.

Then, on Tuesday the 6th the head of the German chamber of commerce and industry warned that German investments into Britain were being held back by PM May’s refusal to start Brexit talks until next year.

This is an evolving situation, and we would strongly warn about complacency over the Pound’s recovery as a result.

Euro to Enjoy Near-Term Strength

Morgan Stanley meanwhile remain bullish on EUR noting the Eurozone economy has held up well post-referendum, supported by the recent release of eurozone August PMIs.

Economists are now expecting the ECB to ease only in December instead of September, with the risk that it may not ease at all, supporting their bullish EUR view.

"Even if the ECB extends its QE programme or cuts rates further, we think it will not be able to push down long-term bond yields substantially to weaken the currency, as eurozone bond yields are already low or negative," say Morgan Stanley.

This should ensure any rebound in GBP/EUR is ultimately limited.

EUR may weaken against USD but it is argued this would likely be driven by USD rising broadly if the market prices in a greater likelihood of Fed rate hikes.