British Pound Rally Against Euro and Dollar Saps Strength from FTSE 100

The British Pound appears to be putting the Brexit blues behind it and is establishing a base, but the strength could be short lived as we have a big Bank of England interest rate decision due Thursday.

• Pound to euro exchange rate today: 0.90% higher at 1.1858
• Pound to dollar exchange rate today: 1.28% higher at 1.3163
• Pound to Australian dollar exchange rate today: Unchanged at 1.7247
• Pound to Canadian dollar exchange rate today: 0.63% higher at 1.7155

The British Pound continues to benefit from the positive spark fired at the start of the week when it was announced Theresa May will be the next Prime Minister of the UK.

This is good news for markets, businesses, and your everyday citizen who have been starved of certainty ever since the country voted to exit the European Union on June the 23rd.

We know May is committed to Brexit but she is certainly not cut from the same anti-EU cloth as Leadsom. Furthermore, she has years of experience at the highest level in both the UK government and in Europe.

This is certainly a pro-GBP outcome as many feared a Leadsom leadership would have prompted a 'hard Brexit' with meaningful restrictions on free movement which would have perceivably had notable implications for the UK's access to the EU market.

May on the other hand, "is more likely to seek a “soft Brexit” - sometimes called the “Norwegian plus” option - from the EU, which maintains access to the European single market, including financial services, and some (crucially largely symbolic) restriction on free movement," says UniCredit's Chief UK Economist Daniel Vernazza.

UniCredit now believe the Conservative Party will avoid a split and there will not be an early general election.

Theresa May has said “Brexit means Brexit” and the UK will almost certainly leave the EU.

Although May has said she will not be in a hurry to trigger Article 50, "we think she is likely to do so later this year. While the EU has said there will be no “cherry picking” and access to the single market must go hand-in-hand with free movement, a compromise seems likely once the dust settles," says Vernazza.

Latest Pound/Euro Exchange Rates

	Live: 1.1451▲ + 0.07% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1062 - 1.1107
**Independent Specialist	1.1291 - 1.1336 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

FTSE 100 Suffers on GBP's Recovery

The prospect of Article 50 not being triggered until next year, as May has stated in the past, is likely a relief to the pound, helping push it higher despite the probability of a rate cut from the Bank of England on Thursday.

"The FTSE, meanwhile, found little joy in sterling’s rebound, the UK index instead hovering around the 6670-6680 mark it started the session at," notes Connor Campbell at Spreadex, referencing the stalled ascent in the UK's leading stock index.

Global investors have been rushing into the FTSE 100 on the back of Sterling's recent woes to pick up bargain-priced shares.

The FTSE 100 is largely international in nature with its constituents having a global footprint. This ensures the index is not necessarily exposed to any negative domestic fallouts stemming from Brexit.

Can the Bank of England Further Stabilise the Economy?

The currency market will now focus on Thursday’s Bank of England meeting at which interest rate markets ascribe a 75% chance of a 0.25% interest rate cut.

Currency markets have digested the probability and were the Bank to just deliver that one 0.25% cut don’t be surprised if movement in the Pound Sterling complex was limited.

Indeed, it is the unknowns that will provide the fireworks. Could the cut be greater than 0.25%? Could they not cut at all?

What of the quantitative easing programme?

There are many question marks and we would expect the Pound to edge sideways in anticipation of the outcome as markets would not want to be caught at the wrong-end of a big move.

Turning to the latest research, as published in our ForecastsNOW section, there is consensus that the GBP will continue to gravitate lower.

However, there are also an increasing number of analysts who suggest the downside momentum is likely to fade.

Indeed, we have advocated for a more consolidate tone for Sterling in our latest observations having noted the UK unit is heavily oversold. 

Credit Agricole confirm they remain bearish on the currency but note that, “with many negatives in the price already, momentum is likely to ease.”

Furthermore, Credit Agricole believe that investors expecting forceful, pre-emptive easing by the MPC may be disappointed.

“Hence, our less aggressive GBP stance for the weeks to come,” say analysts in a note to clients.

Sterling’s Decline Has Been Orderly, And Will Continue

The post-referendum fall in sterling has been precipitous, “but orderly,” notes Alvin Tan at Societe Generale, perhaps a surprisingly sober assessment to those who have viewed the move lower as nothing short of a financial armageddon.

Presumably Tan acknowledges that much of the decline has tracked the move lower in US-UK interest rate differentials, confirming that we are not seeing panic, but rather the Pound continuing to respect its long-term drivers.

The UK's 10 year real yield currently matches the record lows reached in the spring of 2013.

“Interestingly, the nominal trade-weighted sterling is currently at levels prevailing in March 2013 too, with cable being much lower but the EUR to GBP exchange rate is still slightly short of the 2013 highs (~0.88),” says Tan.

One major flipside of the precipitous Sterling weakness is euro strength.

Tan notes the ECB's nominal trade-weighted euro exchange rate has risen by 4% over the past year and 2.4% calendar year-to-date.

It has admittedly not appreciated much since April 2017, but is trading at the higher end of the one year range.

Societe Generale expect a continued depreciation of Sterling against the Euro into year-end.

This, alongside a reluctant ECB is expected to keep the EUR/USD rate above its recent lows:

“The relative strength of the Euro is a symptom of the ECB approaching the effective limits of its policies.

“This is a key factor in our expectation that EUR/USD is unlikely to hit a new cycle low over the next year, and our view that EUR/USD is trading off Fed expectations more than ECB policies.“

Why a Eurozone Banking Crisis Aids the Euro

The Euro continues to show admirable resilience in the face of mounting concerns over the Eurozone’s banking sector.

The Italian sector, and Deutsche Bank have attracted much attention over recent days, yet they have failed to prompt a decline in EUR.

Why?

Morgan Stanley point out that the weak balance sheets of the Eurozone’s financial institutions will reduce their willingness to invest overseas, resulting in longterm capital exports not being sizeable enough to counteract inflows from the EMU's current account surplus, supporting EUR strength.

The Eurozone, unlike the UK, runs a current account surplus - i.e it is a net exporter which provides the Euro with a sustainable foundation.

Further, Morgan Stanley believe that the probability of an Italian bank rescue is high, as EU authorities will want to reduce the chances of PM Renzi losing the October referendum to keep the currency union intact.

This could completely eradicate any negatives to the EUR that may have ensured the currency didn’t actually trade higher.

US Dollar Could Weaken Near-Term

The prospect of GBP/USD settling above 1.30 could become a very real prospect should the Bank of England decide on just cutting rates to 0.25% and global markets continue to improve.

The GBP is likely to benefit when stock markets are rallying and investors are showing a greater desire for risky assets.

We would expect the USD to weaken over coming weeks as low US yields and a better risk environment support carry trades and commodity currencies.

At the same time, Brexit hasn't been systemic for broader risk markets and as volatility falls, risky assets should remain supported.

We likely need a bigger global economic downside surprise, out of China or possibly the Eurozone, to shake the current environment.