Slowing UK economic growth at a time when growth on the continent is gaining momentum is expected to create a divergence that could push the Pound to fresh new lows against the Euro in 2018.
The Pound-to-Euro exchange rate could suffer sizeable decline in 2018 according to strategists at French bank Société Générale who have updated clients with their latest exchange rate forecasts.
Europe’s common currency might find itself confined to a sideways range for the remainder of 2017 as the kinks created by bullish bets back in the summer are ironed out, but it remains fundamentally undervalued and is likely to have the winds blowing in its favour during 2018.
A fresh surge in 2018 should put it on the front-foot against both the Dollar and Pound Sterling once more.
Key to the Euro's outlook in 2018 are expectations for a continuation of the expansion of the Eurozone economy, and for Kit Juckes, chief foreign exchange strategist at Société Générale the Euro's moves in 2018 are tied to the Eurozone's economic superiority.
“The rest of 2017 may be more about a tired risk rally and the baggage of positions, but the Euro is busily building the foundations of another 10% of upside against the Dollar and smaller but sizeable gains against the Pound,” says Juckes.
Juckes is the latest in a string of institutional analysts who have argued of late the driver of the Euro in 2018 will be economic growth.
Bank of America Merrill Lynch economists expect the ECB to start normalising policy rates with the first deposit rate hike in 2Q19 and the first refinancing rate hike in 4Q. "Given the risk that ECB communication turns hawkish well before that, markets could start pricing in normalization throughout 2019, pushing EUR up," says John Shin, FX Strategist with BofAML.
"The euro area economy is still capable of upside surprises, despite many months of strong momentum. Importantly, as well as showing strong German investment growth, the data also point to a continued positive contribution from net exports. This type of backdrop provides a strong base for EUR strength," says Shahab Jalinoos at Credit Suisse.
The Euro has gained close to 12% against the US Dollar in 2017 after a solidifying economic recovery on the continent coincided with the greenback becoming heavily overbought in the wake of President Donald Trump’s election.
EUR/USD shown at daily intervals. Captures 2017 rally and subsequent correction.
“The divergent trends in growth between the US/UK and Eurozone/Japan are likely going to drive currency markets in the months and year or two ahead,” says Juckes.
Equally, Europe’s improving economic fortunes have come at a time when the Pound is being pinned to the floor by uncertainty over the UK’s future trading relationship with the European Union.
Pound-to-Euro rate at hourly intervals. Captures recent price action.
“The two Anglo-Saxon economies are slowing and over time will likely continue to slow, and their currencies have probably seen their best levels,” notes Juckes. “The US Dollar is overvalued, and while the pound isn’t, the UK does have Brexit to keep the currency glued to the floor.”
UK economic growth slowed from 2.9% in 2014 to 2.2% in 2015, 1.8% in 2016 and is on course to finish the current year at around 1.5%. A similar but lesser slowdown has also been seen in the US.
“Over the same period, there has been a clear acceleration in growth in Japan and the eurozone, partly due to the success of expansionary fiscal policies (Abenomics) and partly due to very accommodative monetary policies,” says Juckes.
After the Eurozone debt crisis saw the common currency bloc lag the rest of the developed world in the years up to 2014, since then, the continental economy has quietly turned a corner. In 2016 the common currency area grew by 1.6% and in 2017, is projected by the European Central Bank to grow by around 2.2%.
“In the very short term, the Euro has over-reacted in anticipation of early monetary policy normalisation, but it’s got a good way further to go over time,” says Juckes.
The Euro rose sharply against the Pound from 0.86 pence in June to more than 0.93 pence in September, pushing the Pound-to-Euro rate down to 1.0826. This is while, against the Dollar, Europe’s currency went from 1.1200 in June to 1.2000 during September.
Pound-to-Euro rate at weekly intervals. Captures pre and post-referendum trading.
Driving the rally were hints from the ECB that it could soon begin winding down its quantitative easing (bond buying) program, although both Sterling and US Dollar weakness played their parts too.
“In the very short term, CFTC data still suggest that the market is too long Euros for the next move higher to start,” adds Juckes suggesting patience ahead of a more sustained increase will be required.
The Euro’s summer gains proved short-lived after the ECB disappointed markets when it left the door open for it to continue buying European bonds (QE) after the September 2018 exit point traders had come to envisage.
“But growth underpins the euro and the yen fundamentally. They’re both cheap to Purchasing Power Parity,” says Juckes. “The BoJ is mandated to keep the yen down, but the ECB’s on the path to policy normalisation, and I can’t see why EUR/USD shouldn’t be at 1.30 within 12-18 months.”
Juckes and the Societe Generale team forecast the Euro-to-Pound team will close the 2017 year at 0.92 pence, which puts the Pound-to-Euro exchange rate at 1.0870.
Societe Generale’s 2017 forecast implies substantial downside for the Pound-to-Euro rate, which currently trades at 1.1240, over the next month.
In 2018, Juckes forecasts EUR/GBP will go to 0.97, putting the Pound-to-Euro rate at a little over 1.03.
Euro-to-Dollar, on the other hand, is forecast to close 2017 around its current level, at 1.1800, before trading higher to 1.2500 at the end of 2018.
The Pound was quoted 0.50% higher against the Euro during early trading Monday, placing the Pound-to-Euro rate at 1.1261.
Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.