British GBP/EUR Defends 1.42 Support in Shallow Markets

The pound to euro exchange rate broke above the 1.42 area following an Autumn Statement boost and will try to defend the recovery in thin market conditions.

The pound is sitting above the 1.42 support zone against the euro ahead of the weekend. UK GDP data came in as expected with 2.3% being recorded for the third quarter, exactly where markets had expected to see growth. Because the reading was as expected the impact on the sterling exchange rate complex was minimal.

Market conditions are thin owing to the US long weekend which in turn gives many other market participants across the world a reason to knock-off for a break.

In thin markets moves can be exaggerated so volatility could be a feature ahead of the weekend.

The GBP exchange rate complex holds the recovery prompted by the Autumn Statement mid-week. 

The sterling to euro exchange rate has moved higher to 1.4238 at the time of writing while the pound to dollar exchange rate has recovered to 1.51 from a floor seen at 1.5053 ahead of the spending review.

"The price action in the pound surprised us as the rates market is already priced for no rate hike in the UK until the very end of 2016/early 2017," say Lloyds Bank in a note to clients confirming the sense of surprise amongst traders regarding the recovery.

The recovery came after a poor period of trade following the appearance of  the Bank of England’s Mark Carney and his associates before UK law makers on Tuesday in which we got the message that 2017 is the most likely date for an interest rate rise. The path higher for sterling is if that date is brought forward. 

In fact the falls were deep enough to prompt us to predict that the pound would be unable to achieve its July best again.

Latest Pound/Euro Exchange Rates

	Live: 1.146▲ + 0.15% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.107 - 1.1116
**Independent Specialist	1.13 - 1.1345 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

What have currency markets liked?

• 2016 GDP growth has been upgraded from the 2.3% forecast made in July to 2.4%
• 2015/2016 budget surplus revised lower to 73.5BN, from July forecast of 74.1 BN. Markets had forecast Osborne would today announce 74.4BN.
• GDP capital spending to rise while welfare spending falls
• Tax credit cuts scrapped
• 10.1 BN surplus in 2019/2020

Less cuts are needed to achieve the budget surplus, the scale of spending cuts over next four years will in fact be half what they were in the last parliament. [Note that this is a big deal for the pound's 2016 performance, see more on this below].

The final debt target will however be maintained due to stronger expected tax receipts and a lower interest rate burden.

"We caution against this justification given a number of uncertainties. Furthermore, we view growth projections as being on the optimistic side, especially until 2017," says Francois Cabau at Barclays.

We have heard from a number of currency analysts that deep spending cuts, along with the EU referendum, were two major weights that would hamper sterling upside in the year ahead.

“Along with Japan, current IMF projections show the UK as among the biggest losers in the G10 space in terms of 2016 GDP outcomes from fiscal retrenchment," says Shahab Jalinoos at Credit Suisse who predicts a shave to near-term growth on the back of cuts.

Markets believe that the drag on the GBP that spending cuts were expected to deliver may have been over-exagerated.

If this indeed the case and the UK can deliver on its growth forecasts over 2016 it is hard to see why pound sterling will not remain supported as the Bank of England will surely bring forward its interest rate raising agenda.

The majority of institutional analysts polled by Reuters are forecasting the pound to euro exchange rate to finish the year at 1.44.

Beware: Pound Sterling to Underperform in 2016

Despite the lighter fiscal consolidation announced by the Chancellor, the good times for the pound v euro bulls is about to come to an end according to ABN Amro who have released their latest long-term forecasts which maintain spending cuts will be an issue.

Analysts at the bank say sterling will be the weakest performing major currency in 2016 in their view.

"Fiscal consolidation, past sterling strength and the fear of a Brexit will weigh on UK growth and result in a later start of the BoE lift-off that currently is anticipated in financial markets," says Roy Teo at ABN Amro.

Analysts say they expect that the UK government will hold a referendum on Brexit in the third quarter of 2016.

"It is unlikely that the BoE will hike before this referendum. Therefore, we pushed our first rate hike to November 2016 from August. Financial markets still expect a one rate hike of 25bp and a 50% probability of another rate hike in 2016," says Teo.

If ABN Amro are correct then locking in these high GBP to EUR exchange rates could be a decent idea.