"As GBP/USD rose through $1.4150 and GBP/EUR headed up towards €1.15, USD and EUR buyers were tempted to top up hedging levels, with the GBP/USD rate at post Brexit highs."
Sterling may face increasing downward pressure against the Euro as the 2018 year rolls on, according to NatWest Markets, although recent action (or inaction) by large segments of the business community suggests there may be some scope for the exchange rate to rise in the short term.
The forecasts come at an inflection point for the Pound, which has been knocked around of late by an increase in global financial market volatility and renewed unease about the trajectory of the Brexit negotiations.
These factors have seen Sterling halve its earlier 5% gain over the US Dollar, chopping it back to just less than 2.7%, while pushing it to a fractional 2018 loss against Europe’s common currency.
“Since the beginning of 2018, the GBP has enjoyed a further rally,” says Neil Parker, an FX strategist at NatWest Markets, an investment bank owned by RBS Group. “However, for much of January corporates, and in particularly importers, did not come back into the market to top up hedging (EUR and USD buying).”
Before now, Sterling had gained sharply over its North American and continental rivals in the six weeks to the end of January, as markets grew optimistic that the Brexit negotiations were finally beginning to get somewhere.
Signs the UK economy was gathering steam were also a factor, as they supported market expectations that the Bank of England could soon pick up the pace of its interest rate rises, an idea that was confirmed by the Bank in its February policy statement.
The Pound reached a high of 1.4344 against the Dollar in late January but has since fallen back to 1.3867, while the Pound-to-Euro rate has spent the last two months trapped in a range spanning the gap between the 1.12 and 1.15 thresholds. It is currently sitting on a 0.28% loss for 2018.
“The opposite was true with regard to GBP/EUR, in that hedging activity had already been fairly light, forward points were against EUR buyers and the rally had been much less impressive,” says Parker.
“There was also the comment that budget rates, which had been set prior to the end of 2017, meant businesses were still trying to achieve €1.15 on an outright basis, which would have meant a spot rate in the €1.16s.”
Many businesses, particularly Pound-to-Euro buyers, appear to have held off from transactions during January in the hope that better rates would soon become available. This could suggest an expectation the Pound-to-Euro exchange rate may improve in the short term.
In fact, NatWest Markets own forecasts support this view, as they have pencilled in a Pound-to-Euro rate of 1.18 at the end of the first quarter 2018.
However, this would be about as good as things get because NatWest also have the exchange rate falling progressively throughout the rest of the year, to a low of 1.1200 by the end of December.
“That said, as GBP/USD rose through $1.4150 and GBP/EUR headed up towards €1.15 USD and EUR buyers were tempted to top up hedging levels, with the GBP/USD rate at post Brexit highs,” says Parker.
The outlook for the Pound-to-Dollar rate is more favourable to Sterling users than is the case with the Euro, as NatWest forecast the exchange rate will trade back to 1.40 by year end and for it to average close to this level over the course of 2019.
“In GBP/USD particularly, some of those asked explicitly stated that concerns/fears around Brexit, and the ability to hedge at $1.45 beyond the date of the UK’s EU exit, drove them to enter into further USD purchases,” Parker adds.
The 1.45 Pound-to-Dollar level has proven enticing to import businesses who need to buy US Dollars suggesting corporates, who are the real movers and shakers in foreign exchange markets, are not holding out for a rise above this point in the short term.
Tellingly the export community, which depends on being able to buy back the Pound as cheaply as possible, has also found the recent move below the $1.40 level for the Pound-to-Dollar exchange rate enticing.
“The recent moves below $1.40 and towards $1.23 in GBP/USD and EUR/USD had attracted some interest from those various sectors and from the conversations we’ve had, all in funding at around $1.40 and sub $1.25 in GBP/USD and EUR/USD respectively seemed to be the objective,” says Parker.
Pound Sterling buyers include the Dollar earning community of oil and gas companies, financial services companies as well as food and drink exporters.
All told, recent action and inaction by UK plc could belies a tacit expectation that the Pound-to-Euro rate could see better days in the short term, and that both Pound-to-Dollar buyers and sellers are happy doing business somewhere between the current market rate of 1.3867 and 1.45.
NatWest Markets forecast the Pound-to-Euro rate will finish 2018 at 1.1200, which is in line with the 1.1220 level seen on Wednesday, and the Pound-to-Dollar rate will close the year at 1.40.
Above: Natwest Markets Exchange Rate Forecasts
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