Pound Sterling's Grind Lower against Euro and Dollar Set to Continue

- GBP softer in wake of Bank of England event
- Down on the week against all major currencies
- GBP/EUR could go as low as 1.0870 in next three months
- But expect a recovery when EU and UK inevitably reach a deal

Pound Sterling

Image © Adobe Images

The British Pound's losses against the Dollar, Euro and the other major currencies extended ahead of the weekend with traders continuing to sell the currency in the wake of the Bank of England's decision to boost quantitative easing by £100BN and persistent concerns that a deadlock in EU and UK trade negotiations would persist right up until year-end.

Indeed, Sterling is expected to continue taking direction from Bank of England policy decisions and Brexit trade negotiation headlines for the foreseeable future and at the current juncture the market is of the opinion neither of these drivers are helpful.

"As expected, the BoE increased its asset purchase programme and negative rates will likely be considered in 2H20. However, we still think that the GBP will remain heavily influenced by Brexit negotiations," says Roberto Mialich, FX Strategist at UniCredit Bank in Milan.

"We maintain a cautious near-term outlook for the GBP in view of the very negative growth impact of the Covid-19 pandemic on the UK economy. The prospects for the currency are further made more complicated by persistent Brexit uncertainty and the economy’s weak external position," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

The market's negative skew on Sterling is reflected in the currency's performance for Friday which reveals losses against all its major competitors, which confirms the market is taking note of the currency's idiosynchratic vulnerabilities. 

Pound is day's worst performer

Above: GBP is the day's worst performer

"The GBP is undervalued and oversold, but weak growth outlook and Brexit uncertainty could keep it close to the lows for most of this year," says Marinov.

The Pound is in a short-term downtrend against most major currencies, something that is reflected in the currency's weekly performance that shows it has lost ground against all its major peers.

Looking at Sterling's two key crosses, the Pound-to-Euro exchange rate has fallen one percent this week to trade at 1.1034 at the time of this article's update, meanwhile the Pound-to-Dollar exchange rate has fallen 1.27% to trade at 1.2408.

Pound to Dollar this month

Above: GBP/USD this June

The Pound fell 0.73% against the Euro and 1.0% against the U.S. Dollar on Thursday after the Bank of England opted to boost quantitative easing by £100BN, which was in line with market expectations.

However, there is a sense that the chance of further rounds of quantitative easing lie ahead given the Bank's expectation that the UK could see a jobless recovery: while the economy has turned a corner the Bank expressed concern that job growth would take months to catch up.

"Given the immediate market reaction it appears investors were hoping for a little more than the £100bn increase in quantitative easing that has been announced by the Bank of England. Indeed they may have a point in being disappointed by this announcement given the Federal Reserve and European Central Bank are both guiding the market that they will do whatever it takes to keep the economy afloat," says Hinesh Patel, portfolio manager at Quilter Investors.

As such, further rounds of quantitative easing are expected and this likely explains the Pound's near-term softness as the Pound tends to weaken in times when the Bank is boosting quantitative easing and cutting interest rates.

"The broader USD has been making a strong comeback this week. No more so than against the GBP, which came under renewed selling pressure post the BoE meeting yesterday," says Robin Wilkin, Director, Global Cross Asset Strategy at Lloyds Banking Group.

Pound to euro

Above: GBP/EUR performance over the past 36 hours.

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Persistent market concerns over Brexit trade negotiations are also contributing to a broader trend of weakness in Sterling, something which is expected to remain in place for some time yet despite both sides last week announcing another series of negotiations due to take place in July.

Prime Minister Boris Johnson said he believes an agreement should be wrapped up by the autumn if a deal is to be operational at the start of the new year, a view which could yet prove too optimistic according to some.

"Looking further down the road, we think the trade negotiations will follow the same pattern as the withdrawal, i.e. we need to get much closer to the actual deadline on 31 December 2020 before the two sides will be willing to compromise," says Mikael Olai Milhøj, Senior Analyst at Danske Bank.

As a result Danske believe tensions will likely increase over the next to send the Pound lower against the Euro, with risks clearly skewed on the downside due to a rising Brexit risk premium.

During the past two events with elevated Brexit fears, Danske Bank notes the cross moved toward 1.07. But because the 1 July deadline is not the most important deadline (the end of the transition period on 31 December 2020 is), Danske Bank believe there is a limit to how low GBP/EUR will go.

The bank forecasts the exchange rate to trade at 1.11 on a 1-3 month horizon but believe it could test the 1.0870 region in this period in the event of heightened bouts of investor nerves.

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However, looking beyond the next three months there remains a base case that the EU and UK can reach an agreement on goods before year-end, "possibly including some elements of extension to ensure companies can get ready for the new regime," says Milhøj.

"Politicians tend to be reluctant to give in too early, as it would look like the ‘selling price has been too low’. We saw this happening when Theresa May first reached an agreement despite saying ‘no deal is better than a bad deal’, followed later by Prime Minister Boris Johnson when he reached a renewed agreement despite his ‘do or die’ speech," says Milhøj.

The same theory will apply for those on the EU side, particularly France's Emmanuel Macron who will face a backlash from a traditionally very vocal and restive constituency in the form of France's fishing fleet.

France will want to maintain as much access to UK waters as is possible to ensure the viability of their fleet, expect them to fight the matter right until the very end.

When a permanent agreement does ultimately materialise, Milhøj says the GBP/EUR exchange rate will move higher again, "as investors will price out the Brexit premium".

Danske Bank target 1.1630 on a 12 month horizon.

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