Pound-to-Euro Rate Outlook Brightens after ECB Dents Single Currency

-Pound-to-Euro rate outlook brightens after the ECB dents Euro.

-Forecasts suggest 5% upside to April 2017 high possible in 2018.

-Euro-to-Pound offers "selling opportunity" say BMO Capital Markets.

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The Pound-to-Euro rate has risen close to a two-month high and its outlook brightened now the European Central Bank has quashed the idea of an interest rate rise in the summer next year, leading analysts to cut their forecasts for the single currency.

Sterling could now rise by more than 5% against the Euro before the year is out, if the latest forecasts are to be believed, given a deteriorating outlook for the Euro-to-Dollar rate.

Pound-to-Euro is after all a foreign exchange cross rate that is calculated at its most basic level by dividing the Pound-Dollar rate over the Euro-to-Dollar rate. In order for the Sterling to rise against the Euro, the Pound must move further and faster against the Dollar than its continental counterpart does - or fall slower against the Dollar than its European counterpart.

"The ECB has strengthened its forward guidance on rates and removed uncertainty by announcing an end date for QE. We therefore expect EURUSD to hold below 1.20 over the next 3 months. We look for the pair to move to 1.20 in 6 months, says Stephen Gallo, European head of FX strategy at BMO Capital Markets, in a note Thursday. " Periodic squeezes on long-EURUSD exposures will likely continue to occur. EURUSD longs remain impatient due to the carry associated with holding that position."

The European Central Bank said Thursday it will continue buying €30 billion of European government bonds each month until the end of September 2018, at which point the rate of monthly purchases will be cut to €15 billion before being reduced to zero at the end of December. This should have been a positive development for the Euro.

However, the ECB also quashed earlier hopes among traders that it would be in a position to raise interest rates from their record lows in June 2019, dealing a crushing blow to the single currency and a broad swathe of forecasters who had hoped that an end to the era of ultra-low interest rates was near.

"The Governing Council expects the key ECB interest rates to remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with the current expectations of a sustained adjustment path," says the ECB, in its statement.

The Euro-to-Dollar rate fell back close to a year-long low in the 1.15 area following the ECB's decision on Thursday as markets had come to believe that an interest rate rise would not only be possible, but likely, in the Eurozone as soon as June 2019. This was why currency traders had got so excited about an end to the ECB's quantitative easing programme and had previously bid the single currency 17% high against the Dollar during the year to April 2018.

"Amidst a strengthening labour market, we expect GBPUSD to rebound to 1.38 in 3M and for the BoE to deliver the next rate hike of the cycle in August. We expect a resumption of USD weakness to drag GBPUSD to 1.53 in 12M. Given the trend in the BoP data, the UK’s external position is no longer a source of downside risk for the GBP," Gallo writes of the Pound-Dollar rate, in a separate briefing back in May.

The combined effect of bullish Pound-to-Dollar rate forecasts and downbeat Euro-to-Dollar rate projections is to create a positive outlook for the Pound-to-Euro rate. Friday morning saw the Pound-to-Dollar rate fall to 1.3235 while the Euro-to-Dollar rate dropped to 1.1554, giving a Pound-to-Euro rate of 1.1452. This is close to a one-month high but year-end forecasts of 1.44 for the Pound-to-Dollar rate and 1.20 for the Euro-to-Dollar rate suggest the Pound-to-Euro rate will end the year at 1.20, which is 5% above Friday's level and would be the highest exchange rate since April 2017.

"The strength of the UK’s labour market and a Brexit process that refuses to spiral out of control justify at least one hike staying the curve by year-end. Political risk in the Eurozone should also dampen the EUR’s ability to rally. In the event of a weaker-than-expected UK CPI print tomorrow, I would look to fade the rally in EURGBP. In the event of a hawkish ECB on Thursday, I would look to fade the rally in EURGBP. All in all, this should translate into a EURGBP selling opportunity in the vicinity of 0.8850," Gallo wrote to clients earlier this week, advocating a strategy that is equivalent to buying the Pound-to-Euro pair.

The Pound-to-Euro rate was quoted 0.07% lower at 1.1454 during the morning session Friday while the Euro-to-Pound rate was down at 0.8732. The Pound-to-Euro rate has risen by 1.7% for the 2018 year to date. 

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