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Pound Sterling Forecasts Cut at Swiss Private Bank, but Euro seen Ending Year Higher vs. Dollar

- Range between 1.28 and 1.32 to hold

- Bank of England and trade negotiation tensions to weigh on Sterling

- Euro forecast to appreciate in 2020

Pound Sterling

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The British Pound forecasts held at Swiss private bank Lombard Odier have been slashed, with analysts citing anxieties over the EU-UK trade negotiations as well as the 'dovish' shift adopted by the Bank of England.

The lowering of forecasts come amidst an ongoing setback for the Pound, which is trading lower against the Euro, Dollar and the majority of the world's major currencies since the start of 2020.

"We have pared our sterling forecasts to reflect dovish comments by MPC members that will likely lead the market to start pricing in an earlier rate cut," says Vasileios Gkionakis, Head of FX Strategy at Lombard Odier. "There are still supporting factors for the exchange rate that limit the downside, but there are also a number of headwinds that will cap any rallies.

Following what Gkionakis describes as "an extraordinary period" for Sterling in 2019, the currency is heading into more sober times once more as the UK and EU grapple over their future trading relationship and the Bank of England mulls cutting interest rates in response to a slowing economy.

On the matter of trade negotiations, the sizeable majority of 80 secured by Boris Johnson's Conservative Party was expected by some corners of the market to mean the Prime Minister had secured himself the luxury of striking a trade deal that was to his liking.

In short, a practical and realistic trade deal would not be derailed by hard-liners on either side of the European argument, as was so often the case during Theresa May's tenure.

However, the message in 2020 from the Prime Minister and his senior ministers has been clear: the UK will be diverging away from European rules, even if this means facing barriers to trade as a result.

Markets have interpreted the robust stance adopted by Johnson to mean negotiations could break down and the UK and EU are unable to strike a free trade deal. Or, at the very least, there will ample levels of anxiety to keep Pound Sterling under pressure over coming months.

"Given the highly complex nature of the trade negotiations and, hence, the very low likelihood of the two sides reaching a comprehensive deal in the space of less than a year, investors have begun to re-price in the “cliff-edge” premium and sterling has weakened across the board in the last three-four weeks or so," says Gkionakis.

The Pound started the current week on the back foot following weekend comments by Chancellor of the Exchequer Sajid Javid that the UK will not be seeking alignment with EU rules, and therefore UK businesses must be prepared for any repercussions brought about by such a stance.

But it is not just international politics that might prove a headache for Sterling over coming months: the Bank of England and the performance of the UK economy are making a comeback as an important driver of Sterling following a lengthy absence in 2019.

This year a number of Bank of England Monetary Policy Committee members have lined up to warn that the slowdown in the UK's economic growth rate could warrant an interest rate cut, aimed at supporting growth rates and inflation.

A side effect of central bank interest rate cuts is often a weaker currency, and this has certainly been true of Sterling in 2020.

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The message delivered by the Bank of England has been hammered home by some poor economic data releases, including news that the economy shrank in November, while retail sales out last week showed a sharp slump in December.

"December’s fall in retail sales volumes comes as a major shock and suggests that consumers retrenched severely at the end of last year amid heightened political uncertainty," says Samuel Tombs, Chief U.K. Economist at Pantheon Macroeconomics. "Five months now have passed without a month-to-month increase in sales, the longest spell without growth since record begin in 1970."

With the economy showing itself to be struggling in late 2019, and with lingering trade anxieties, the fundamental backdrop for Sterling is understandably unsupportive.

However, whether or not the Bank of England cuts interest rates could ultimately rest on how the PMI data due out on Friday lands. Bank of England MPC member Gertjan Vlieghe said he would be voting to cut interest rates on January 30 unless the PMIs out on Friday showed a material pickup in activity.

With the caution on the market keeping a lid on Sterling, we would warn readers to be beware of a Sterling-positive surprise. Many leading indicators out over the course of January have indeed pointed to an outcome whereby the data beats expectations.

The latest sign of improved sentiment came from the Royal Institution of Chartered Surveyors (RICS) who said the housing market got a boost from Johnson's election win in December.

A measure of new buyer inquiries hit its highest level since before the Brexit referendum in 2016.

Andy Chaytor, a rates strategist at Nomura, told Reuters the housing market was one of the best early indicators of economic activity in Britain and he thought the stronger RICS report would lead to a modest increase in the looming PMI reports.

 

Predictions for the Pound

Ultimately, Lombard Odier have lowered their forecasts for Sterling.

The Pound-to-Dollar exchange rate to trade at 1.30 by the end of March, down from 1.33 previously. The exchange rate is forecast at 1.31 by the end of June, down from 1.34. It is forecast at 1.32 by the end of September, down from 1.35 and 1.33 by year-end, also down from 1.35.

"For investors with long-term horizons, we feel that the most prudent course of action is to stay on the side-lines pending more clarity. For those interested in higher-frequency trading, we believe playing the range between 1.28 and 1.32 would be a reasonable approach for the time being," says Gkionakis.

A broader strengthening in the Euro should meanwhile weigh on the Pound-to-Euro cross rate. "We have held a constructive view on the euro in the past few months," says Gkionakis.

The Pound-to-Euro exchange rate is forecast to trade at 1.15 by the end of March, a level it is predicted to remain at until year end where a level of 1.1627.

 

Three Reasons to Expect a Stronger Euro

A strengthening in the Euro in 2020 is to be expected according to Lombard Odier analystss, who see an improvement in the Eurozone economy as providing a fundamental basis for appreciation in the currency.

"We remain cautiously bullish on the Euro, targeting 1.15 by the end of the year with the risks tilted in favour of some further upside. We see three fundamental factors unfolding over the course of 2020 that are likely to support the common currency," says Gkionakis on the expected path of the EUR/USD.

1) The difference in growth rates between the Eurozone and U.S. is expected to swing in the Euro's favour over coming months, "it is not so much a story of euro-area growth rebounding strongly... but rather one of US growth slowing," says Gkionakis.

Lombard Odier forecast U.S. growth will cool from 2.3% year-on-year to 1.8% in 2020.

2) The Eurozone is expected to benefit from a cooling in temperatures between the U.S. and China over trade, "this development is a positive for euro area exports, and consequently should support the exchange rate," says Gkionakis.

3) Flows of investor capital into Eurozone stocks are increasing. "Following years of euro-area equity underperformance vis-à-vis the U.S., stabilising regional growth should leave plenty of room for the inflows to continue, and this historically has been associated with euro appreciation," says Gkionakis.

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