Disappointment for Euro Buyers as Brexit Transition Deal not a 'Game Changer' for the British Pound

- Markets nervous of "complicated" negotiations on future trading relationship

- UniCredit: Pound-to-Euro exchange rate to be "relatively stable" over coming weeks

- But, Pound-Euro exchange rate forecast at 1.19 by year-end by Danske Bank

Brexit transitional deal agreed

© European Union, 2017 / Source: EC - Audiovisual Service / Photo: Lukasz Kobus

The Pound buys 1.1431 Euros on the inter-bank market at the time of writing, this week's high is seen at 1.1471 while this week's low is at 1.1411. It appears that solid run of gains we have seen through much of March might have finally run their course.

Indeed, we have canvassed the views of a number of leading foreign exchange analysts in the industry and many agree the British Pound could be confined to more sideways action against the Euro over coming weeks as the recent breakthrough in Brexit negotiations turning out to be something of a damp squib for Sterling.

We have been reporting that the securing of a Brexit transitional deal - that period that lasts two years in which the settings between the EU and UK remain the same - was crucial to the Pound's outlook.

And last week, the EU and UK reached an agreement on a transition period lasting from 30 March 2019 until year-end 2020. The Pound rose against the Euro on the announcement that an agreement had been reached by Brexit negotiators, but there has been little significant follow-through in the GBP/EUR exchange rate.

Many readers hoping for a stronger Pound were primed for the announcement to finally deliver the kind of gains they need to offer a notably better exchange rate agains the Euro, instead the Pound is actually today quoted near the highs that it was quoted at on the announcement of the Brexit transitional deal.

One week on, and there is little to show for the progress.

"While positive, it is not the game changer and in any case a deal was widely expected," says Mikael Olai Milhøj, Senior Analyst with Danske Bank. "The negotiations on the future relationship are going to be much more complicated, not least with respect to the outstanding Irish border issue."

It could therefore be that the transitional deal was indeed crucial for Sterling's outlook; but the deal was widely expected and therefore the Pound preempted the outcome. We can therefore assume that had no deal been reached the markets would have been surprised enough to punish Sterling, so there are some positives for Sterling bulls to take from this.  

Milhøj does not expect GBP/EUR to move significantly higher "before we get more clarification on what the future relationship is going to look like".

Other analysts agree that those hoping for a better exchange rate against the Euro need to be patient.

Since the autumn of last year, GBP/EUR has fluctuated between 1.15 and 1.11 - an area in which the exchange rate "is likely to remain comfortable in the coming quarters," says Esther Reichelt, an analyst with Commerzbank.

Pound to euro exchange rate graph

Above: We can see GBP/EUR has been tracking sideways since September 2017.

Economist Chiara Silvestre with UniCredit Bank in Milan confirms the announcement on a Brexit transition is "good news that should support the currency over the medium term" but reminds clients that the Euro is also likely to remain supported by the positive economic narrative in the Eurozone.

As a result, the GBP/EUR exchange rate is expected to remain "relatively stable" and it "looks unlikely to break out of its established range which is identified as being between 1.15 and 1.11.

Therefore, 1.15 could be as good as it gets and the long-term sideways trend remains intact.

Barclays - the UK high-street lender - has meanwhile told clients that they are not expecting the Pound to deliver any fireworks near-term.

Analysts at the bank have been optimistic on Sterling's chances for some months, but now believe the good news is now fully reflected in the Pound.

"Our expectations for near-term GBP appreciation materialised last week after the UK and the EU reached an agreement for a 21-month transition period, while higher wage growth solidified market expectations for a May BoE rate hike," says Hamish Pepper, a foreign exchange analyst with Barclays.

However, if those who need a better exchange rate with which to make international payments can exercise some patience, we are told they will likely be rewarded as the multi-month outlook should still yield gains in Sterling.

 

Longer-Term Gains Still On

However, while the Pound and Euro are widely tipped to remain rangebound in the near-term, Danske Bank do believe that ultimately Brexit negotiations will progress in a pro-Sterling direction.

Patience is required however as they target GBP/EUR at 1.1627 in six months and 1.19 in twelve months.

Danske Bank's call for an higher Pound against the Euro is also supported by the Bank of England, as the BoE March meeting has not changed their view that the BoE will hike twice this year (May and November).

This is a view shared elsewhere with analyst Lefteris Farmakis at UBS saying he believes  expectations for future interest rate rises at the Bank of England will increase in response to the transitional deal being struck; and that will be important for Sterling.

"Most of the upside for Sterling is likely to arise from the more traditional channel of rate differentials rather than risk premium unwind," says Farmakis in a recently released client briefing.

UBS calculate for every 25bps of additional rate hikes priced in for the BoE vs ECB, the GBP/EUR rises by c.2%. The repricing of the relative policy stance by a modest 25-50bps is fairly plausible, in their view.

Accordingly, sterling could gain by up to 4% vs EUR, implying an upper bound for GBP/EUR at around 1.1765.

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