Brexit Risks Dominate 2016 for Pound v Euro Rate, But 1.49 Target Seen at ING

The pound to euro exchange rate (GBPEUR) will strengthen in 2016 by ING, but there is one major hurdle that could well trip the trend.

"It if things change we will do what's necessary." - Mark Carney, BoE Governor on the Bank's reaction to the EU vote outcome.

PM David Cameron has put forward the key requests for the changes that need to be made in Europe if the government is to campaign for the UK to stay in the EU at next year's referendum.

This represents a gear change higher in the debate over EU membership. So far Brexit has failed to hit the value of the British pound, but analysts tell us the risks are real and the closer we get to the vote the more volatile GBP rates will become.

Tapping into the debate are Bank of America Merrill Lynch who have said Brexit, and the period in the run up to the vote, will likely be a negative event for both the UK economy and the pound exchange rate complex.

Adding to the GBP-negative tone Brexit presents are ING who say political risk is likely to be one of the key factors holding GBP from advancing in 2016.

"We forecast a low-point in Cable next year at 1.40 in 2Q16, while EUR/GBP may correct back to 0.70 around the same time, having traded to 0.67 earlier in 2016," says Chris Turner at ING in London.

Turning the equation around, EURGBP at 0.67 sees a maximum of 1 GBP = 1.4925 in 2016 while 0.70 sees 1 GBP = 1.4286. This is significantly higher then we are seeing at the moment, but the message we find to be relevant is just how volatile the exchange rate could become.

Latest Pound/Euro Exchange Rates

	Live: 1.1452▲ + 0.08% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1063 - 1.1108
**Independent Specialist	1.1292 - 1.1337 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

The way forward is therefore higher, but watch for potentially dangerous volatility as the heat around the Brexit vote grows.

For reference, ING had calculated a 1.5-2.0% risk premium embedded into GBP/USD right ahead of the Scottish referendum.

"That risk premium could easily be double were opinion polls to swing towards an Out vote," says Turner.

Ignore those news sources that blame Brexit for any current moves in the British pound - there is no evidence that this is the case and such sources are short on insight.

"There appear few signs in the GBP options market that any particular date is being favoured for the Brexit referendum. In reality it is far too early for this to appear," says Turner.

Indeed ING’s analysis confirms even though the 18 September 2014 Scottish independence referendum was announced a year earlier – it was only at the start of September 2014 (and the release of some close opinion polls) that the options market really started to take notice.

And looking at the term structure of euro to pound option prices currently, there does not appear to be too much event risk priced into the 2016 calendar.

The curve from the start of next year (2m plus) is gently positive-sloping, which is generally the case for the options’ curve.

According to Turner shorter term dates (out to year-end) are driven by supply and demand and no doubt by the key event risks of ECB (3 December) and Fed (16 December).

Bank of England Will Seek to Provide Soft Landing Regardless of EU Vote

Bank of England Governor Mark Carney has meanwhile said the institution he heads will take the necessary steps to ensure any UK exit from the European Union is as smooth as possible.

"Our job is to make whatever the British people decide work," Carney told Sky News. "And there's a status quo, we're making that work and we think it is working, but if things change we will do what's necessary."

We believe the Bank doing ‘what’s necessary’ amounts to an interest rate cut from the present 0.5% or a delay to any rate rises just as markets are agressively positioning for a hike.

The Bank has hinted in the past that it is willing to make a further cut to the already record low 0.5% base rate.

Even ahead of any such move there are downside risks to the British pound.

If the Bank does not raise interest rates in early 2016 then we could see a new theme emerge - the Bank of England basing further delays to rises on emerging political uncertainty over the referendum.

The conditions for a lacklustre 2016 for the pound sterling are growing.