Forecasts for the British pound have been revised lower by analysts at Lloyds Bank.
While sterling is still predicted to gain against the euro in 2015 the climbs will be less far-reaching than previously anticipated.
The news comes as we move through the early stages of the year in which the pound to euro exchange rate (GBP/EUR) has already reached a peak at 1.3504 which leaves it looking stretched in short-term timeframes.
The Driver Behind the Lloyds Downgrades
Following the dovish November Inflation Report delivered by the Bank of England, and signs of a softening in some of the forward-looking economic indicators, Lloyds Bank currency forecasters push back their central view on the timing of the first UK Bank Rate rise from February to August 2015.
Indeed, as we move through February consensus for the first rate hike is being pushed yet further back with conesensus estimates placing the first hike a year later in August 2016.
At the same time, "we have brought forward our central view of the timing of the first hike in fed funds to June 2015 from September previously. This reflects the slightly more hawkish FOMC statement in October and the ongoing tightening in the labour market," says a note from the bank.
So while the US dollar is expected to gain as the flow of money into the US economy increases to take advantage of higher interest rates the same does not yet apply to sterling as yields will likely be kept lower through 2015.
The change in central bank policy rate expectations has implications for the main G10 FX forecasts held at Lloyds.
"We have lowered end 2014 and end 2015 targets for GBP/USD to 1.59 and 1.53 this month. EUR/USD is forecast at 1.25 and 1.22, with EUR/GBP at 0.79 and 0.80, respectively," says the note to clients.
Therefore GBP/EUR is forecasted at 1.2658 and 1.26, lower than the current levels being witnessed. If Lloyds is right then those seeking euros could be seeing favourable levels to transact at.
The Pound to Euro Forecast Profile
Looking at the pound euro rate we see that in the opinion of Lloyds a test of 1.30 is highly unlikely.
This contrasts to other bullish projections that suggest 1.40 may eventually be tested.
"GBP/EUR is also expected to weaken from the second half of next year, as conditions in the euro area improve," says the note.
Since mid-October, GBP/USD has dropped by over 3% to a 14-month low of 1.56, taking its cumulative decline since its mid-July peak (of $1.7194) to nearly 10%. Even against the euro, the pound has lost ground, falling from €1.28 to €1.25 which markets the bottom of the sideways range.
"Near term, we believe the drop in the pound looks overdone. Although we now expect the first rise in UK Bank Rate to occur in August next year, the markets continue to discount a more benign outcome. Consequently, we believe there is scope for sterling to recover a little over the coming weeks, and target $1.59 and €1.27 at end year," say Lloyds.
Sterling has been unable to break meaningfully higher against the euro, undermined by a scaling back in UK rate hike expectations, a deterioration in the UK’s external balance and the continued resilience of the US dollar.
Technical Indicators Call for Futher Gains
While Lloyds base their call on future direction largely on fundamentals, the technical outlook would suggest the bank is under-estimating the GBP's future path.
Analyst Lilian Lillicrap at brokerage AFEX has taken a look at the charts and says should a breach of 1.35 occur further gains could well be possible:
"Interim resistance at 1.3500 looks to be capping further Sterling gains initially but given an underlying positive technical environment re-emergent weakness here should remain corrective only.
"Whilst additional preparation might prove necessary before continued (sustainable) advances are witnessed enough compression is already evident from this multi-year basing pattern beneath 1.3000 to enable an extension to and beyond the 1.4000 level going forward as well.
"Recent Euro-based selling here left the market over-extended from a shorter term perspective but fresh dips will uncover good/regular demand starting in the 1.3275 area (additional support existing at 1.3200 and then 1.3125) with downside potential otherwise seen as limited."