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Barclays says further British pound upside against the euro is to be expected.
Boosted by widening French bond spreads, the pound-to-euro exchange rate should remain supported, even as sterling faces its own test at the budget later this month.
Short-term, the pair looks overbought, as the rapid ascent to 1.1820 leaves it stretched: the daily chart now shows a significant standard deviation away from the 21-day moving average and the RSI above 70, the line that signals overbought.
Reflecting the stretched nature of recent gains, the pound has retreated from Monday's highs, which were also likely exacerbated by Asia's thinner liquidity that leaves early Monday trade prone to wild swings.
A settling in the mid- to late-1.17's for GBP/EUR is therefore appropriate nearer term, even if the overall setup continues to advocate for further upside.
"In all, risks are skewed for further euro downside in the coming weeks and months," says a weekly FX note from Barclays.
Analysts at the bank say the euro's appeal as the main "anti-dollar" alternative has been on the wane for some weeks now, but that status took "a further blow by the sharp widening in OAT spreads last week."
France's bonds - OATs - have dropped in value sharply, forcing their yield higher.
Above: GBP/EUR daily with key RSI in lower panel indicating overbought conditions.
The net result is that the cost of government borrowing surges at a time when the French government can ill afford it. "Fiscal problems are daunting enough in their own right, but are made even harder to fix by the upcoming presidential election and a hung Parliament where consensus building has often proved to be an impossible task," explains Barclays.
The fate of the 2027 Budget recently presented by Prime Minister Lecornu's government has therefore acquired extra significance as a potential trigger for near-term bond market and FX relief.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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Talk to a specialistThe administration is pushing a €54BN belt-tightening package that aims to bring the public deficit down from an expected 5.4% this year to 5% in 2027
Barclays says that represents only a "marginal deficit reduction" and impending elections dampen prospects for more credible fiscal tightening while external risks bring Europe's energy vulnerabilities back to the limelight.
Above: The UK ten-year minus the French 10-year bond yield.
Don't Forget Britain's Own Budget
France's woes mean markets have taken their eye off the upcoming UK Budget, where the risk is that Prime Minister Andy Burnham attempts to increase spending without the requisite tightening elsewhere.
The government has repeatedly committed to following the fiscal rules, suggesting it is very awake to the risks of making a mistake.
For the pound, the split fortunes between France and the UK is significant; "the pound was among the key beneficiaries from the widening in French spreads last week," says Barclays.
"French developments are likely to remain the primary driver for EURGBP," it adds.
The House View Still Stands: Pound Sterling to Remain Supported
Pound Sterling Live in August published its House View, which forecast that the pound would end the year higher than where it traded at the time of publication, based on the view that the market was too negative on its prospects.
At the core of the view was the UK economy that continued to outperform expectations, pointing to an underlying resilience that the bearish consensus forecasts for sterling were failing to recognise.
The View expected the October budget to be a potential stumbling block that would constrain the currency, but once passed, upside would be more readily realised.
The view holds; however, the French saga was unexpected and has impacted the view in two ways:
1) it's unlocked pound-to-euro upside earlier and more aggressively, while
2) pressuring pound-to-dollar via the safe-haven angle.
Nevertheless, the sterling index - the trade weighted measure of the pound - is still on course to fulfil our House View prediction.
And the wildcard scenario remains intact: an early election called by Andy Burnham based on poll ratings that put Labour clear of an irretrivably split vote on the right.
Daniella Arcadipane, Senior Currency Specialist at Indigo
Moving a life-changing sum abroad? You won’t be doing it alone.
One specialist explains every step in plain English and stays with it until the money lands. FCA authorised, FRN 594433.
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