Pound-Euro Week Ahead Forecast: Upside Bias Intact but Volatility Likely Ahead

- GBP/EUR volatility may rise after across-the-board RMB gains
- Disrupted RMB’s automatic stabilisers, could draw PBoC action
- May prompt mitigating bids for CFETS FX inc EUR, GBP et al
- As USD causes headaches for central banks across the board

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• GBP/EUR reference rates at publication:
• Spot: 1.1638
• Bank transfers (indicative guide): 1.1330-1.1412
• Money transfer specialist rates (indicative): 1.1448-1.1560
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• Set up an exchange rate alert, here

The Pound-to-Euro exchange rate could be volatile with an upside bias this week if a recent across-the-board uplift in Renminbi exchange rates leads the Peoples’ Bank of China (PBoC) to buy non-Dollar currencies in a bid to fend off appreciation pressures coming from the Dollar.

Sterling was 0.2% higher and above 1.16 against the Euro by the close last week following remarks from Gertjan Vlieghe, an outgoing Monetary Policy Committee member at the Bank of England (BoE), who said in a Thursday speech that interest rates could rise at the BoE as soon as the middle of next year.

“A lot of good news is priced in. Still, at least the good news keeps coming. The latest nugget was the Lloyds business barometer for May, which rose to a three-year high, with economic optimism at its highest level since 2016,” says Daragh Maher, head of FX strategy, U.S. at HSBC.

There’s little from the domestic economic side to influence the Pound-to-Euro exchange rate further over the coming days unless BoE Governor Andrew Bailey has anything interesting to say in a 16:00 speech on Tuesday that is headlined "Building a Finance System Fit for a Clean, Resilient and Just Future."

In any case, a quiet domestic scene doesn’t necessarily mean the Pound won’t be found both rising and falling at times in what could be a volatile week for the currency market at large; Not if last week’s price action across all Renminbi exchange rates leads the PBoC into action.

Above: Pound-to-Euro rate shown at daily intervals alongside GBP/USD.

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For those who missed it, China saw significant gains across pretty much all of its exchange rates following an apparent decision to allow USD/CNH to fall in a manner that might already have done had the PBoC not spent so long successfully attempting to keep it above the landmark 6.40 level.

“Although there seems to be broad acceptance of a weak USD amongst investors, we don't detect such a resounding consensus on China's economic fundamentals in terms of their ability to drive RMB appreciation (other than 'they're fine'),” says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

The move came amid concern in Beijing over rising Dollar-denominated commodity prices and could’ve been motivated by a desire to offset that increase through a stronger exchange rate, although this has caused increases in other Chinese exchange rates that are a macroeconomic pitfall for the PBoC.

Above: Renminbi exchange rate quotes and performances over selected timeframes.

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After being combined with ongoing weakness in other key parts of the currency market last week’s USD/CNH fall has had the effect of lifting the Renminbi against all China Foreign Exchange Trade System (CFETS) currencies and at a point when the Renminbi was already at three year highs in trade-weighted or overall terms.

“We’re also watching the CNY/JPY cross – this has rallied 15% since last summer. Japanese policy makers will welcome this, Chinese policy makers less so,” says Chris Turner, global head of markets and regional head of research at ING.

Widespread Renminbi gains are problematic for the PBoC because they make imported goods cheaper to buy and with other kinds of inflation being too low for PBoC policy targets, these gains could motivate the bank to buy other currencies in a bid to reduce its other exchange rates.

Above: China Foreign Exchange Trade System index basket of currencies.

“We're still going to stick our necks out and opine that RMB appreciation (or a prolonged period of USD weakness) could easily become headaches for policymakers. We expect additional administrative tools to be deployed by the PBoC through the remainder of the 6.30s,” BMO’s Gallo says.

For those who missed it, China saw significant gains across pretty much all of its exchange rates following an apparent decision to allow USD/CNH to fall in a manner that might already have done had the PBoC not spent so long successfully attempting to keep it above the landmark 6.40 level.

In Europe the most important currency within the overall CFETS index, which is the basket against which Renminbi exchange rates are measured as well as occasionally managed, is the Euro and so this would be the primary recipient in Europe of any PBoC attempt to fend off extreme currency appreciation.

GBP/EUR has often done well as EUR/USD rises wherever the single currency has been rising during periods when the European Central Bank (ECB) is downbeat on its economic and inflation outlooks: This is when it’s most often heard pushing back against currency strength.

However, anything that gives cause for the Euro to appreciate in its own right would be a downside risk for the Pound-to-Euro rate.

“Wednesday will see the ECB release a report on the international role of the euro. These typically look at the role of the euro in things like FX reserves, invoicing and debt issuance,” says ING’s Turner.

“We would expect to see a further advance in the EUR in all of these categories – aided by President Trump's and the US Treasury’s use of sanctions, and the rest of the world trying to break free from dollar hegemony. The report could throw out some bullish headlines for the euro.”

Above: Renminbi Vs CFETS index currencies.

For readers’ background; China operates a managed floating exchange rate regime.

This means Renminbi exchange rates reflect market supply and demand, but with the PBoC involving itself wherever the macroeconomic and financial stability needs of China require it to do so; or otherwise for reasons related to China’s international responsibility as a major economy.

“Market supply and demand is [an] important reference. The floating and flexible exchange rate is an outcome of these two factors combined with necessary management,” writes a guest commentator on the China Foreign Exchange Trade System (CFETS) website in December 2015 when the CFETS index was first launched.

This is no secret nor need it be controversial because the market is a no man’s land which necessarily serves the currencies, economies and countries of the world, all of which have different cultures and customs.

Nonetheless, it could matter very much in the week ahead and because of the impact that U.S. policies are having on the Dollar.

An ‘America First’ monetary policy at the Federal Reserve (Fed) is sponsoring for a new and Corbynite White House something like a magic money tree, which has driven a tidal wave of capital away from the Dollar in horror during the last year.

The Dollar was already on the verge of becoming a problem currency again even before Sterling or any other currency stepped foot into 2021: And if this reality isn’t handled with great care, it could very easily drag the world into what many pundits like yours truly would inevitably call a ‘currency war.’

For further background readers could do worse than take a look over the following:

The Untold Story of Pound Sterling's Steamrolling Rally

Pound Sterling in Central Bank Bid as Peoples' Bank of China Eyes Win-Win Cooperation

U.S. Dollar On the Verge of Becoming a Problem Currency Again

Currency Wars are Real and the BoJ is Assembling A New Rifle