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Pound to Euro Rate: Beware a Capitulation Lower

UK Inflation data to watch

The British Pound is recovering from recent lows against the Euro thanks to some better-than-forecast employment and earnings data but we hear from one leading analysts that the GBP/EUR could be destined to fall as low as 1.11 again.

  • US Fed could shake markets later on Wednesday
  • Bank of England is centrepiece for Sterling on Thursday

The GBP/EUR exchange rate trades at 1.1925 in the wake of the release of UK employment and earnings data. 

This constitutes a recovery for the exchange rate which was trading as low as 1.1880 earlier in the day.

Despite the small bounce, the pair appears to be losing the required conviction to break above the key 1.20 region that we have been eyeing for a number of days now. 

We would have to assume that unless the US Federal Reserve and/or the Bank of England are able to stimulate the required buying interest this could be a temporary top for the pair.

Analyst Robin Wilkin at Lloyds Bank Commercial Banking maintains a bias for a move back towards 1.11 but acknowledges that the pair needs to fall below key support at 1.1668-1.1614 to confirm such a move.

So those with an eye on the exchange rate should watch this area with keen interest.

“For now the trend from the 7th October highs remains intact,” says Wilkin saying a break of the 1.2121 resistance region would force him to review his medium-term outlook for a range between there and 1.11.

The immediate risk would be for a steeper rise towards 1.25-1.2579, but it would also call into question Lloyds' longer-term analysis that can still see a re-test of the 1.0204 lows set back in 2008.

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Sterling Finds Relief from Strong Wages and Employment Data

The ONS has reported on Wednedsay December 14 that wages in the UK are on the up with average earnings, with bonuses inclided, have reached 2.5% for the month of October.

Analysts had only forecast a reading of 2.3% - the Pound tends to strengthen when estimates such as this are beaten.

The data confirms UK wages are outstripping inflation which essentially means the average Britton is getting richer; a welcome piece of data in the context of the uncertainty provided by looming Brexit negotiations.

Interestingly, it would appear that the construction sector is proving to be the engine of wage growth:



But there were further positives for Sterling in the news that the claimant count - i.e the number of people on benefits but looking for work - had risen by 2.4K, analysts had forecast a greater rise of 5.5K.

Once again, that the data was better-than-expected is what really counted for the Pound.

Inflation Boosts the Pound but Still Tipped to see Strength Fade

The UK currency retains a positive momentum thanks to a combination of pro-business Brexit developments and an official data release that showed UK inflation rose 1.2% in November.

The data was forecast to read at 1.1% confirming that prices are rising faster than economists had anticipated.

The growth in prices suggests the 2% level targeted by the Bank of England could soon come under pressure.

Foreign exchange markets are betting that the Bank now has no room to cut interest rates any further and the next move on rates could actually be higher.

Raising interest rates is the Bank's most formidable tool when it comes to fighting inflation, and higher interest rates are typically positive for Sterling as global investors will send their money to the UK to take advantage of any superior rates paid by bonds.

The ONS reports that the largest downward pull on inflation in November 2016 and for 2016 to date comes from prices for food and non-alcoholic beverages.

Prices in all other broad categories rose in the year to November. This is the first time since mid-2014 that all non-food categories had an upward effect on inflation.

The Pound’s ~15% fall since the EU vote has ensured imports to the country have risen notably and this should start being felt by UK consumers who have for years enjoyed sub 1% inflation.

"The 2-year high in the CPI rate was largely caused by Sterling’s weakness and a higher oil price, with higher CPI prints likely in 2017. Given the upward pressure on inflation, the BoE’s move towards a more neutral policy stance is understandable given that it has indicated that its patience for inflation to overshoot the 2% CPI target is limited,” says Shilen Shah, Bond Strategist at Investec Wealth & Investment.

The matter will only become more acute now that oil prices are rallying on cuts to production made by OPEC.

Indeed, transport prices created a downward pressure during 2015 and early 2016 but have since become the largest upward pressure reports the ONS.

Analysts at ING forecast inflation to hit 3% in the second-half of 2017. “As wages are unlikely to keep with rising consumer prices, the hit to real wages will be very apparent through 2017”, says Petr Krpata at ING in London.

However, Krpata is wary of chasing the British Pound higher on the back of today's data as they expect the Bank of England to look through the higher prices as activity data will remain subdued.

“Any overshoot in Sterling higher triggered by false hopes of a potential tighter BoE policy should be faded, while resulting lower real rate should not bode well for the currency next year, particularly if the political noise around the Article 50 increases,” says Krpata.

Krpata's assessment is therefore not a bullish one with regards to GBP's outlook, and if he is correct then the ability of GBP/EUR to break and sustain 1.20 are limited.

Ahead Today: US Federal Reserve

There are some big news and economic events due today that could shake the Pound.

The big event is the US Federal Reserve's policy decision, due at 19:00 GMT. An interest rate rise is almost certain.

However, the rate rise itself will not be enough to move the Dollar and therefore the Euro and Pound.

Rather it is guidance pertaining to interest rate moves in 2017 that will really matter to markets. Watch the evolution of the dot plots which show the expected movement in interest rates over coming months.

If the dots move higher we would expect the Dollar to move higher. The Pound has actually done well against the Euro when the Dollar rises, so this could fuel GBP/EUR upside.

Ahead Today: UK Employment Data

We saw inflation give the Pound a nudge on Tuesday, can the employment series deliver the same?

The data is released at 09:30, and it will be positive for Sterling if the Average Earnings INdex +Bonus beats 2.3%. The claimant count is forecast to read at 5.5K.

Ahead Thursday: Bank of England

Thursday brings with it guidance from the Bank of England at midday. No decision on interest rates are expected, but just as is the case with the Fed, investors will be keen to know what the Bank is thinking when it comes to raising or cutting rates in 2017.

As mentioned already, the latest inflation data suggests inflation is en route to breaking the 2% inflation target the Bank strives for.

Will the Bank blink and suggest they will not tolerate high inflation for an extended period? If so this could be taken as a sign that the next move in rates could well be higher. 

This would be interpreted as a pro-GBP outcome.


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