"Go Long GBP vs EUR" in 2023 says Danske Bank

• EUR/GBP a sell in 2023 says Danske
• "Now attractive to go long GBP vs EUR"
• But RBC says EUR/GBP is a buy

Image © Adobe Images

Danske Bank's foreign exchange research team is selling the Euro and buying the British Pound in 2023 as they expect the Eurozone's industrial slowdown to be a key market theme over the coming months.

The trade forms part of Danske's thematic playbook for the coming year in which analysts say energy will remain a key theme, as was the case in 2022.

This would leave the Euro particularly prone to energy exporters, such as NOK, CAD, AUD and USD, says Danske Bank.

"We argue that a broad capex cycle still seems elusive for 2023 and that this will continue to mark a headwind to industrial heavy currencies like EUR," says Kristoffer Kjær Lomholt, Chief Analyst at Danske Bank.

As such Danske Bank sticks with a short EUR/USD through 2023 as they look to repeat one of their most profitable trades of 2022.

"We generally believe the main investment environment will be characterised by weak global growth, tight liquidity and elevated energy prices through 2023. Amid this, we see an even lower EUR/USD as the post-COVID deleveraging process continues," says Lomholt.

But analysts at the Scandinavian institution say the British Pound is another currency set to take value from the Euro.

"After a tumultuous autumn for GBP, we believe it is now attractive to go long GBP vs EUR," says Lomholt.

The Pound to Euro exchange rate is down 2.40% for 2022 but the pair has recorded a 7.0% recovery from its September lows, making for a strong final quarter.

Recent market developments take spot back to 1.1625, although near-term a breach of 1.17 looks to remain elusive as the market enters a consolidative phase ahead of a busy mid-month event calendar.

Retail market indicators show exchange rates at the typical high-street banks have returned to around 1.13-1.14; at competitive cash and holiday money providers rates are closer to 1.15. At transfer specialists rates around 1.1590 are being quoted.

Above: "EUR/GBP trading in tandem with Global PMI" - Danske Bank. Consider setting a free FX rate alert here to better time your payment requirements.

The research behind Danske Bank's call shows EUR/GBP usually moves in the same direction as the world PMI manufacturing index:

Danske Bank says the EUR/GBP-PMI correlation was notable in 2013-14 when global manufacturing was accelerating (EUR/GBP rose) and in 2014-16 when global manufacturing was decelerating (EUR/GBP lower, although Brexit limited the effect in 2016).

Most recently, during the manufacturing slowdown in 2018-20 (EUR/GBP lower) and the rebound after the COVID-19 crisis (EUR/GBP higher).

"With the outlook of energy prices to remain elevated, we also see this favouring a lower EUR/GBP," says Lomholt.

Analysts readily point out that both the UK and Eurozone are equally exposed to the Europe-specific energy crisis.

But Danske Bank notes although both are net energy importers, the UK remains less dependent on energy imports favouring GBP through relative terms of trade.

"Additionally, we see large-cap UK stocks as offering a relative appeal to investors in a stagflationary environment. Given their defensiveness, record valuation discount, large dividends and the factor tilt towards inflation, investor inflows may prove a tailwind for GBP," says Lomholt.

Above: GBP/EUR at daily intervals showing performance in 2022. If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.

The current environment suits the energy and commodity-intensive FTSE 100 which has outperformed in 2022, rising 2.0% in the twelve months to date.

This compares with a 10% decline in Germany's DAX and a 17% decline in the S&P 500.

Politics was a major source of weakness for the Pound in 2022, but Danske Bank says the recent stabilisation under Prime Minister Rishi Sunak should ensure calmer waters for the currency.

A key risk to the trade is a sharp sell-off in risk where capital inflows fade and liquidity becomes scarce, which would make Sterling vulnerable as the UK runs a large current account deficit.

Strategists at RBC Capital Markets are meanwhile buyers of EUR/GBP in 2023 largely because of the UK's current account deficit.

"September's 'fiscal event' may have brought the UK imbalances into sharp focus, but they were there before the short-lived policy changes at that time," says Elsa Lignos, Global Head of FX Strategy at RBC Capital Markets.

These imbalances are:

1) The budget deficit. The UK maintains a long-running budget deficit as the government continues to spend more than it earns in taxes. The OBR forecasted in November that the UK's debt burden would rise to a peak of 99% of GDP over the next three years.

Debt is forecast by the OBR to be roughly £400BN higher than had been forecast in March, and interest costs accrued to service these debts would be close to historic highs.

2) The current account deficit. The UK's current account remains in deficit as the UK imports more than it exports, meaning it buys more foreign exchange than it earns.

This leaves the Pound relying on the inflow of foreign investor capital to maintain valuation.

"They are still there now, with budget and current account deficits running at 6%+ of GDP and the need to keep drawing in foreign capital making a strong case for grinding GBP losses," says Lignos.

"The case for remaining negative on GBP is strong," she adds.

RBC Capital also bet against the Pound in 2022, but the currency at the other end of the trade was the Canadian Dollar.

"In pure G10 trades, the best performer was short GBP/CAD and we still like the short GBP leg of this trade," says Lignos. "All but one of our longer-term thematic trades for the year delivered positive returns and again for the aggregate of all trades, it was a record year.

A look at Danske Bank's recent form shows their thematic trades for 2022 yielded a positive accumulated return of 0.5% (equal weight).

The hit ratio was 6 out of 9 and the two top positions yielded 6.0% and 3.8% in profits, respectively.

Their short GBP/USD and short EUR/USD positions were their best-performing trades, yielding profits of 6.0% and 3.8%.

Both investment banks can therefore boast about their predictive powers, but it looks like only one can be right when it comes to calling the Pound vs. Euro in 2023.