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Pound Sterling has Overreacted to May Election Announcement, seen 5% Overvalued Against Euro

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Pound Sterling is overvalued by up to 5% against the Euro at current levels according to new research.

Analysts at UniCredit S.p.A have told clients the Euro is now attractively valued and speculators would do well to bet on a recovery against Sterling.

The Italian bank’s research team have been long-term bears on the British Pound, and have apparently opted to maintain this stance in a week that has seen many in the industry take a more positive shine to the UK currency following the recent decision by the UK Prime Minister to call elections for June 8.

"Sterling has overreacted to PM Theresa May’s unexpected call of an election on 8 June but we remain skeptical that this rally will last for long: we still expect a deterioration of the UK economy in the coming months," says Roberto Mialich, FX Strategist at UniCredit Bank in Milan.

And following the correction lower, “EUR/GBP is now trading at levels that appear quite attractive to go long,” say UniCredit in a client note dated April 21.

‘Going long’ is trader-talk for betting on a move higher.

UniCredit note that since the outcome of the UK referendum back in June 2016 the area just above £0.83 has not been seriously challenged to the downside and constitutes a strong support zone.

Looking at this from a Pound to Euro exchange rate angle, £0.83 equates to £1.2048.

1.2048 is therefore resistance to further Pound Sterling upside.

We have actually heard this number bandied about by a number of other analysts recently.

We wrote earlier this week that the GBP rally against EUR could stall at this level. “EUR/GBP is on its way to reach, test and break below 0.83 as the uncertainty of the French Presidential elections weigh on the Euro,” says Georgette Boele at ABN AMRO Bank in Amsterdam.

UniCredit argue the recent drop in the Euro has been the result of two forces that have compounded each other: on one hand, Sterling has rallied due to the announcement of the snap UK election, and on the other hand, the euro is currently under pressure from political risk premia as the French election draws closer.

“We think the bounce in the GBP is more related to a short squeeze than a structural, and hence, long-lasting, shift,” say UniCredit. Others agree. The election announcement, “has been a good enough reason for another squeeze in short GBP positions – in our opinion the most credible explanation for GBP’s post-announcement rally,” says Viraj Patel, a strategist with ING Bank N.V. in London.

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UniCredit's Reasons to Back the Euro

Earlier this month Kathrin Goretzki, FX Strategist at UniCredit Bank A.G. in London told us that “while the biggest adjustment in Sterling is likely behind us, we think it is too early to turn bullish on the GBP."

UniCredit see several reasons for EUR-GBP upside:

1.  "We do not see Mrs. May’s announcement of snap elections in the UK as fundamentally supportive of sterling. Britain’s bargaining position in the negotiations with the EU is unlikely to improve, even on the back of a more unified stance by the UK government;

2.  "UK data resilience, to a large extent, reflects the pickup in global growth. We expect to see increasing signs of divergence over the quarters ahead as high inflation erodes UK real incomes and confidence;

3.  "We expect the Euro to rally if Marine Le Pen does not make it to the Elysée (our base case). Although the currency has started reflecting somewhat less nervousness about the French election result, there is still a political-risk premium that will likely be priced out once the French election is over."

Looking at the difference in yields being offered on Eurozone and UK sovereign bonds - a key driver of currency value - UniCredit estimate that EUR/GBP should be trading around 5% higher.

“We believe this wedge is likely to close over the next few weeks,” say UniCredit.

Analysts do however acknowledge that being the upcoming two rounds of the French presidential election represent a hurdle that carries with it a certain degree of uncertainty and the market response would very likely be binary: Euro higher if Le Pen loses but sharply lower if she wins.

“Hence, we would advise investors to consider obtaining long exposure through short-dated (around 1M) call optionality rather than directly through spot,” say UniCredit.

Also telling us that he favours the Euro going forward is analyst Kit Juckes at Societe Generale.

Juckes says he still believes it is still a wise bet to be long on the Euro to Pound exchange rate as a core trade in 2017.

Juckes comes at the issue from another angle saying the UK has a savings problem which is "frankly, frightening."

The UK economy is holding up well as Brexit approaches, but it's living on credit," says Juckes in a note dated April 19.

Pound's Outlook Upgraded at Credit Suisse and Deutsche Bank

While UniCredit are clearly no fan of the Pound at this juncture we have seen other analysts turn more positive on the currency of late.

Credit Suisse have this week put clients on notice of impending upgrades to their Pound forecasts citing the more positive landscape a larger Conservative majority will bring to the Brexit spectrum.

In a note to clients dated April 19 Credit Suisse say they are looking to bump up their forecasts for Sterling following “the latest ‘out of the blue’ event that is Theresa May's decision to call for a UK general election on June 8.”

The move has been well received by GBP, “based on the thesis that the Conservatives are likely to win by a landslide and have a clear mandate to push through Brexit negotiations without too much inconvenient domestic opposition,” say Credit Suisse.

However, the final exchange rate forecast changes will only be forthcoming once the French presidential election has been settled.

Also turning more positive on the UK currency are arch-bears Deutsche Bank who who have conceded that Theresa May's decision to call an election turns the tables in favour of Sterling.

They are to update clients on their latest forecast targets at some point in coming weeks.


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