The Euro to Pound exchange rate (EUR/GBP) will weaken in the short-term but continue to rise thereafter confirm strategists at investment bank Morgan Stanley.
Strategists tell clients they are holding onto opinion that the Euro will better the Pound longer-term despite concerns put forward by other analysts that the Euro might now be overvalued.
A short period of British Pound outperformance should however be expected however.
Their modification of the timing sees, "one more leg down in the EUR before we use the opportunity to buy,” says Morgan Stanley strategist Hans Redeker.
A final leg up in GBP caused by easing political uncertainty is likely to further aid the correction (rising Sterling equals falling EUR/GBP), as the, “Conservatives should form an agreement with the DUP with details announced ahead of the Queen's speech.”
At the time of writing no deal has been reached between the DUP and Conservatives, potentially delaying any recovery in Sterling.
The view that EUR/GBP could weaken in the near-term echos that put forward by technical analysts who have noted how the pair rolled over at the top of a longstanding range and appears to be headed south now.
"Price action has touched upon the upper channel constraint and is now slowly pulling back, towards the 20 DMA,” says Blackwell Global’s Steven Knight, who expects the pair to move bakc down to the range lows in the vicinity of 0.83 in the short-term.
The bottom-line though is GBP strength, wherever it is seen, is not sustainable as deteriorating UK economic data is likely to undermine the currency.
Indeed, we have seen the Pound fall notably on Tuesday, June 20 after Bank of England Governor Mark Carney told an audience that now is not the time to raise UK interest rates.
The Pound fell half a percent against the Euro on the viewpoint being made clear.
For Morgan Stanley, a decline in ‘real wages’, that is wages after inflation, is the main concern regarding the economy.
Weaker earnings will impact on consumer spending which although it is currently the highest in the G10 is ripe for a fall.
“The UK has seen the fastest rise in consumption over the past year among the G10, suggesting it is unsustainable now that real wages are negative,” commented Redeker.
MS does not see a threat on the horizon from the Bank of England (BOE) hiking interest rates, however.
“The BoE having 3 members voting for a hike is not sufficient for a hike to be announced at the August inflation report,” they said.
MS advocate buying EUR/GBP on the dips.
The Euro, meanwhile, will gain on hopes of a move to greater integration – especially fiscal and banking.
Euro-area equity market inflows are still robust, further aiding the currency - and positioning is no longer extremely bearish.
Back in May strategists advised traders to buy EUR/GBP at 0.8520, targetting a rise to 0.9200 with a stop-loss set at0.8370 incase the Pound appreciated.
EUR/GBP Limited Longer-term
Analysts at Credit Agricole are in agreement with Morgan Stanley over the short-term in which they see the Pound rising but they differ in seeing upside for the EUR/GBP longer-term as severely limited.
The Euro is overvalued against the Pound, according to CA's Velentin Marinov, and this limits how high the pair can go.
Indeed, CA only see it gaining in the circumstances of a ‘hard’ Brexit ie a return to WTO tariffs.
“Long EUR/GBP still seems to be the best hedge against a potential hard Brexit,” says CA.
Marinov forecasts the pair to rise to 0.90-95 in a hard Brexit scenario.
Otherwise the pair is overvalued, according to most gauges of ‘fair value’.
“Our short-term valuation analysis suggests that GBP looks expensive vs USD and Scandis, and cheap relative to EUR, CHF and JPY.
At the same time, our long-term valuation model still suggests that the best hedge against a potential hard or disorderly Brexit may be long EUR/GBP,” said Marinov.
Pound to Rise in the Short-term
Like Morgan Stanley, Credit Agricole see the Pound rising in the short-term, and therfore EUR/GBP falling.
They view the politically uncertain environment in which PM Theresa May has no outright majority as actually positive for the Pound as it mitigates against a hard Brexit.
The ambiguous election result means there is now more chance of the Tories reaching out across the divide and agreeing a ‘soft’ Brexit.
“The election outcome may reduce the risk of a very hard Brexit. Indeed, given their weakened position in parliament, investors expect the Tories to reach out across the divide when devising their Brexit strategy. This seems consistent with recent comments by some key members of the Brexit negotiation team,” said CA’s Marinov.
Another theme expressed in the ambivalent election result is the rejection of austerity, which could also be supportive of GBP.
“Some clients seem to believe that the election may lead to a period of a relatively lax fiscal stance that could help support the recovery at a time of heightened uncertainty about Brexit,” said CA.
The greater fiscal looseness would be supportive of Sterling.
Longer-term, however, Marinov defers comment on the Pound, seeing too many variables on the horizon to be able to risk a forecast.
“We defer our assessment of the longer-term outlook for GBP to a later date when we will, hopefully, have more indications about the likely shape and form of the Brexit deal, and the fiscal policies of the UK government,” he said.
GBP/USD is well below fair value, indicating it has already priced in a lot of bad news and more downside is therefore unlikely. A hard Brexit is priced in at between 1.20-25.
EUR/GBP is overvalued, on the other hand, and therefore at risk of a breakdown unless Brexit negotiations increasingly turn ‘hard’.