Latest institutional analysis suggests Brexit-inspired volatility could push EUR/GBP well beyond 0.80 in the run up to the referendum ahead of a sharp decline towards the end of the year.
- EUR to GBP exchange rate at 0.8046 today
- "The firming of Brexit risks should keep EUR/GBP above 0.80" - ING on the coming 3 months
- "Brexit risks are exaggerated on the basis of previous UK voting patterns" - Bank of America in forecasting a strong GBP recovery
How much more of a negative impact will the EU referendum have on the British pound?
This is arguably the single most important question for the GBP exchange rate complex at present as uncertainty surrounding the outcome poses big question markets for the future of the UK economy.
Maybe the UK will be better off outside Europe, maybe it won't. Maybe nothing will change if the UK leaves.
This debate is irrelevant from a currency perspective at this stage; what matters is that currencies hate uncertainty and uncertainty is all we have at present.
In the recent past sterling has endured volatility on the back of political events of a similar nature to the EU referendum in the form of the Scottish referendum on independence and the 2015 General Elections.
Analyst Petr Krpata at I.N.G in London argues that based on past experience, and taking into account just how more important the EU vote is, the pound has more risk to absorb.
Absorbing risk, in this context, means declining as investors would not want to be exposed to a currency until they are sure it won't fall any further when confronted with an 'Out' vote.
"Looking back a how much risk was priced into GBP ahead of the 2014 Scottish referendum, and then the 2015 UK general election, we feel that a larger risk premium is required in GBP crosses now. The firming of Brexit risks should keep EUR/GBP above 0.80,” says a note from ING's
They see 0.82 as the upper threshold going into the referendum as Brexit risks may also start to weigh on the euro, due to fears of the referendum sparking copy-cat referenda amongst other members.
This will cap euro gains, say ING, limiting any upside to 0.82.
The shadow of Brexit is so pervasive it has clouded the once positive effect of good economic data, something the British pound has relied on since 2013.
The positive economic momentum has continued over recent months but, “this is not being reflected in the UK rates market which remain reluctant to recalibrate their view on the timing of the first UK rate hike until the event risk of the Referendum is out of the way,” says Kamal Sharma at Bank of America Merrill Lynch.
The lack of movement in market interest rates – which tend to represent investors’ inflation expectations - reflect an uncertainty by markets as to when they expect the Bank of England (BoE) to increase base interest rates.
Currencies tend to rise with interest rates.
This is because foreign investors prefer to invest their money in countries with higher interest rates, as they get a better return; this obviously increases demand for that country’s currency.
So without the promise of higher BoE interest rates sterling has found little upside support.
Expectations for higher interest rats have been put on hold until the referendum; however, once it is over there is likely to be a sudden, swift, revaluation:
“The growing divergence between GBP and UK rate differentials versus its G10 counterparts is presenting a trading opportunity but only when the event risk has passed,” says BofA's Sharma.
BofA Expect Quiet April Followed by Volatile Run-Up
The UK public will vote to stay in the EU according to the base-case scenario held at BofA, and the pound will rise again forcing the euro to pound sterling exchange rate back to 0.7400 in the weeks that follow.
“In our view, Brexit risks are exaggerated on the basis of previous UK voting patterns. We therefore believe that GBP will stage a meaningful recovery following the Referendum and this is reflected in our revised FX forecasts. We look for GBP to recover by the end of Q2 2016 with EUR/GBP falling to 0.74 (-5% from current levels),” says Sharma.
Further, analysts expect April trading to be subdued due to positive seasonal trends counter-balancing any further sterling-negative risk premia inputs.
There will be a delayed reaction after April when marginal opinion polls and the approaching of the referendum date will once again inspire increased volatility in GBP pairs:
“We believe that this will merely delay what we see as renewed pressure on the pound heading into the Referendum. With headline polling still suggesting a close contest, we believe that investors will view the event with a great deal of trepidation. FX volatility is therefore set to remain elevated at the front end of the curve as we approach June 23rd.”
A Strong Recovery
Looking beyond the rederendum BofA forecast a strong recovery by the British pound which should push the EUR/GBP sharply lower.
"Brexit risks are exaggerated on the basis of previous UK voting patterns. We therefore believe that GBP will stage a meaningful recovery following the Referendum and this is reflected in our revised FX forecasts," says Sharma.
Bank of America look for GBP to recover by the end of Q2 2016 with EUR/GBP falling to 0.74 (-5% from current levels) and GBP/USD rising to 1.46.
Technically Speaking EUR/GBP in the 0.79s and Rising
The fundamental discussion here regarding Brexit can be extrapolated into the technical configuration of the underlying market in EUR/GBP.
In short, the charts confirm that further gains for the euro are likely over coming weeks and months.
The EUR to GBP is currently rising after having broken above a rising channel and temporarily poked above 0.8000.
From a technical perspective there are no signs of weakness and the pair is expected to push higher:
“The technical structure suggests that the pair should show continued increase.” Said the broker in a recent note," says Yann Quelann at Swissquote Research.
Quelann's long-term view sees further upside potential for the pair and the next target at 0.8066:
“In the long-term, the technical structure suggests a growing upside momentum. The pair is trading well above its 200 DMA. Strong resistance can be found at 0.8066 (10/09/2014 high).”