Lloyds' Forex Forecasts 2014: British Pound to Euro and Pound to Dollar Exchange Rate Targets Raised

The upgrade of the bank's 2014 currency forecasts arrives as the GBP continues to outperform rivals in global FX markets thanks to ongoing strong data releases.

The pound to dollar exchange rate hit a 5½ year high of $1.7180 in July while the pound to euro came close to a 2-yr high of €1.2633.

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Bank of England a key driver of the pound exchange rate complex at present

Sterling has benefited on the surprisingly more hawkish tone from the Bank of England of late.

BoE Governor Carney said a policy rate increase “could happen sooner than markets currently expect” at his debut address at the annual Mansion House dinner.

"Market expectations of the first hike in Bank rate were brought forward and sterling rallied, with GBP/USD above 1.70 and EUR/GBP below 0.80. The June MPC meeting minutes noted the same concern, although the vote for no immediate change was unanimous," says a note issued by Lloyds.

Moreover, MPC members’ testimony to the Treasury Select Committee later in June was more balanced on the UK policy outlook, tempering market rate expectations and halting sterling’s climb. UK 2-yr gilt yields eased back below 0.9%. However, disappointing US Q1 GDP data and soft euro area figures saw sterling extend gains against the USD and euro."

Upgrading forecasts for the sterling (GBP)

According to analysts the Ongoing UK recovery and rising interest rate expectations have driven the pound higher.

"Given starting levels, GBP/USD targets are raised to 1.68 at end 2014 and to 1.56 at end 2015. EUR/GBP is forecast at 0.79 and 0.78, respectively," say Lloyds.

With regards to the pound to euro exchange rate, the strength of the UK economy has been thrown into stark relief over the past month by weak overseas data and financial instability in Portugal.

The GBP should thus gain on its superior fundamental footing.

However, it is worth noting that there are downside risks ahead for the GBP.

The currency forecast memo notes:

"Near term, there is a risk that preliminary Q2 GDP figures due 25th July may disappoint. The UK’s widening external imbalance also poses a downside risk for the pound.

"Still, with interest rate expectations likely to remain elevated over the summer, there appears little to prompt a significant reversal. Given recent moves, we have revised up our forecasts for GBP/USD and GBP/EUR to $1.68 and €1.27 by year end."

Euro dollar forecast lowered

Contrasting to the pound sterling is the euro which is expected to see its fortunes deteriorate somewhat.

The thinking at Lloyds is as follows:

"The euro has stabilised as the impact of the ECB’s June policy measures is awaited. EUR/USD has ranged between 1.35-137 in the past month. The ECB kept rates unchanged at its July meeting but repeated that it stands ready to act should downside risks materialise.

"Euro area data have disappointed, with the composite PMI falling to a six-month low and German surveys also pointing to slower growth. Euro area inflation was steady at 0.5% in June, well below the ECB’s 2% target.

"Although economic indicators appear consistent with a weaker euro, the strong likelihood that the ECB is unlikely to ease policy anytime soon and the dovish tone from most other major central banks is supportive.

"However, we expect euro area interest rates to remain low for considerably longer than in other major economies. We forecast EUR/USD at 1.32 at end 2014, falling to 1.22 at end 2015."

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