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British Pound Strength Forecast to Fail in Early 2017, Current Rally a 'Cyclical Discrepency'

Foreign exchange analysis

  • Pound to Euro Exchange Rate Today (7-12-16): 1.1792, 0.30% down on the day's open
  • Euro to Pound Sterling Exchange Rate Today: 0.8480
  • Pound to Dollar Exchange Rate Today: 1.2635, 0.36% down on the day

Pound Sterling's multi-week recovery is forecast to reverse early in the new year by a leading technical analyst who describes recent strength as being a 'Cyclical Discrepency'.

Pound Sterling remains near the top of a multi-week uptrend that has resulted from the five consecutive weeks of gains against the Euro and three consecutive weeks of gains against the Dollar.

As a result, the British Pound’s Effective Exchange Rate has recoverd towards 78.81. The Effective Exchange Rate is a measure of Sterling’s value against a basket of its most important counterparts based on trade and is therefore a good gauge as to the currency's overall health.

The Effective Exchange Rate bottomed out at 73.70 in October amidst fears the Government was seeking a clean break from the European Union in what is known as a hard-Brexit.

GBP effective exchange rate

The US Dollar and Euro are understandably the largest constituents of the basket owing to the UK's large trading links with Europe and the United States.

The recovery in Sterling come as the hard-Brexit story gives way to suggestions the UK government could push for a continued membership of the European Union’s single market, even if that access is paid for.

Sterling remains a currency largely driven by sentiment at present and this is certainly likely to be the case over the next year as the UK finally starts to hammer out its future relationship with the EU.

With that in mind, the next big thing for Sterling could well be the ruling of the Supreme Court concerning the Government's ability to trigger Article 50 before March 2017 without the scrutiny of Parliament.

The court case started on Monday 5 December but a ruling is only likely in mid-January - if the Government wins then we would expect the UK currency to slip sharply lower as markets like the idea of the process being made more transparent by Parliament.

"The supreme court case is expected to continue until January, during which time the pound could potentially see a lot of movement," says Paresh Davdra at foreign exchange brokerage RationalFX in London. "However, with the ruling of the high court earlier in the year against the government, it seems likely that the pound will continue to see rises if the supreme court decision appears to favour the argument for Parliamentary scrutiny."

Latest Pound/Euro Exchange Rates

United-Kingdom European-sUnion
Live:

1.1703▼ -0.48%

12 Month Best:

1.1931

*Your Bank's Retail Rate

 

1.1305 - 1.1352

**Independent Specialist

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Pound Recovery a Mere 'Cyclical Discrepency'

Fundamentals such as court cases are nigh impossible to predict.

But, the good news for those needing a steer on Sterling's future direction is that there are good hints and clues to be offered by the technicalities of the GBP market.

What are the structural compositions and trends within the foreign exchange markets telling us about Sterling’s prospects going forward?

Often, technical studies can tell us where the levels are at which long-term trends are likely to turn. With this in mind we are wondering 1) whether the Great Brexit sell-off of 2016 is over and 2) is the October-December recovery sustainable or is it merely a relief move.

Answering the above will allow those with large international payment requirements for 2017 the ability to start planning for better or worse exchange rates accordingly.

“Sterling is currently in a somewhat novel situation given its performance over recent months of finding support against most other G10 currencies but recent gains look at best the result of cyclical discrepancies rather than any major trend reversal,” says analyst Lucy Lillicrap, Head of Advisory Services at AFEX, the foreign exchange brokerage based in London.

Such a discrepancy would be the EUR/USD bottoming out at 1.0465 in April last year and subsequently managing to recover beyond 1.1700 before peaking.

“GBP/USD appears to be in that same mode at present and while 1.2850 or even 1.3000 may be achievable over the next few days neither level is considered sustainable beyond December,” says Lillicrap.

Could a the technicals - that advocate for a return to lower levels - align with the fundamentals in which the Government wins its Supreme Court appeal?

Another potential fundamental scenario is that when Theresa May presents her Brexit plans to Parliament markets don't like what they see.

Either way, there is a heightened chance that in the new year the bias increases to downside moves.

Technical studies observe the large, increasingly exhausted, size of the upside retracement seen already in GBP/USD from a circa 1.1500 low.

Outlook for the GBP/USD: Must Break 1.34 for Trend to Extend

Foreign exchange analysis

For Lillicrap, the most interesting technical question at present so far as the developed currency market is whether or not current USD market action constitutes exhaustion in macro terms: "The preferred interpretation remains that a major watermark high in Dollar Index terms will be seen during either the balance of 2016 or very early on into 2017."

“This scenario fits developments already underway in minor currency pairs and also many commodities as the (characteristic) 5 year cycle of Dollar strength since 2011 naturally reaches a conclusion,” says the analyst.

However an alternate view would argue for sustained Dollar buying for perhaps another two to three years and at the same time increase upside potential in Index terms from 2-5% (left before a major top) to something in the region of 35%+.

“Given this dichotomy it would not thus be surprising if some additional time was taken to consider the ramifications of such break-outs and it may well be that December is characterised by range extension instead,” says Lillicrap.

Shorter-term GBP trends remain positive with GBP/USD breaking up from a narrow range around 1.2500.

However, whilst the market could now extend up to 1.2850 or 1.3050 again we are warned such an extension still looks corrective from an intermediate perspective.

“Unless Sterling values manage to re-accumulate and subsequently hurdle 1.3450 as well no macro bottom will be confirmed. Instead although some support now exists at 1.2490/00 both 1.2300 and 1.2100 areas remain vulnerable once this upside retracement finishes,” says Lillicrap.

Latest Pound / US Dollar Exchange Rates

United-Kingdom United-States
Live:

1.3234▼ -0.5%

12 Month Best:

1.4247

*Your Bank's Retail Rate

 

1.2784 - 1.2837

**Independent Specialist

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Outlook for GBP/EUR: 1.20 Could be the Limit

As with GBP/USD above much of the available upside potential here appears to have been witnessed already in recent weeks and while

“Sterling values are still "stair-casing" their way up to 1.2000 this psychological level should rebuff the market going forwards,” says Lillicrap who warns that without a much more substantial basing structure further gains above 1.2000 should thus prove difficult to sustain.

1.20 was hit on Monday December 5, but the pair quickly sold-off on hitting this, a sign of how heavy resistance is at this point.

Next resistance beyond 1.2000 is at 1.2170 and although some support now exists around 1.1800, 1.1650 and 1.1500 secondary/tertiary demand points then look vulnerable as well once an interim high has been confirmed.

Indeed, these views for a turnaround in GBP/EUR in early 2017 echoe the views held by Societe Generale.

Analysts at the French bank have an eye on France's presidential elections and if Marine Le Pen fails in her bid to become French leader then the Euro will recover it is argued.

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