The GBP/EUR Rate Sees Target Cut After Diplomats Fire Brexit Talk's Starting Gun
- Written by: Gary Howes
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- Quick Quotes:
- Pound to Euro exchange rate today: 1.1360
- Euro to Pound Sterling exchange rate today: 0.8802
Researchers at Danske Bank Markets have released a mid-year foreign exchange market review in which they updated their projections for the main Euro exchange rate pairs.
With regards to GBP/EUR, analysts at the pan-Scandanavian financial services firm have announced downgrades to their forecast targets.
“The UK election outcome was in many ways the worst possible for GBP, and we stress that Sterling will likely stay in undervalued territory during Brexit talks but be highly sensitive to progress in discussions,” say Danske in a briefing dated June 16.
Talks get underway on Monday June 19 and the UK's Brexit Secretary David Davis will call for "a deal like no other in history" as he heads into talks with the EU.
Subjects for these early negotiations include the status of expats, the UK's "divorce bill" and the Northern Ireland border.
Davis said there was a "long road ahead" but predicted a "deep and special partnership".
Brexit negotiations will probably be tough and when details of the talks are made public, there could be some moves on the Pound which has actually been extraordinarily range-bound of late.
While clarity on Brexit terms should brighten the skies for the Pound, appreciation potential should be limited by notably a terms-of-trade deterioration.
“Any appreciation pressure has been postponed,” say Danske.
While GBP/EUR targets are downgraded, damage to the exchange rate should limited as Danske Bank do have reservations as to just how far the Euro will strengthen.
The single-currency has been one of the best-performing major currencies of 2017 but appears to be running out of steam against the likes of the Dollar and Pound.
With the European Central Bank (ECB) set to be side-lined in coming months by a sustained deterioration in the inflation outlook, this should ensure expectations for an interest rate rise at the ECB are tempered.
Analysts further argue the Euro should be vulnerable to a likely loss in cyclical momentum in the Eurozone.
Analysts now look for EUR/GBP to trade around 0.87 throughout the forecast horizon (previously the rate was seen at 0.84 in 1-3M and 0.83 in 6-12M).
From a Pound to Euro exchange rate perspective this amounts to 1.1494. The previous figures were 1.1905 in 1-3M and 1.2048 in 6-12M.
Political Intrigue Key for Sterling Near-Term
For Sterling, the near-term agenda is political.
The Queen’s speech is the highlight for the week (Wednesday), though in the words of one foreign minister the “critical moment” will come next week (June 28/29) when MPs vote on it.
Newspaper reports suggest Boris Johnson and David Davis’ teams are sounding out the prospect of toppling Prime Minister May, while The Times reports Remain backers aim to have a candidate in place by next week (likely Amber Rudd).
Others claim she may be given the benefit of the doubt until the party conference in October. An agreement with the DUP is also expected in the next two days.
On Tuesday, Hammond and Carney are due to give their Mansion House speeches that were postponed from last week.
Markets will be especially eager to hear more from Carney as to where the Bank of England is leaning with regards to raising interest ratse.
Recall, last week the Pound rose following the announcement that three members of the 8-person Monetary Policy Committee had voted to raise interest rates.
If Carney confirms this view is gaining traction amongst other members, or if he himself hints that this is the right course of action, Sterling could do very well this week.
Kathleen Brooks at City Index says a hawkish Mark Carney would be a major shock to the market, as the UK Overnight-Index-Swaps (OIS) market, a way to gauge market expectations for interest rates, is still not fully pricing in a single rate hike by the end of 2018.
"We expect this to be a low probability, but high risk event, which could trigger an initial knee jerk reaction higher in the pound," says Brooks.
Also watch for Chancellor Hammond's stance on Brexit, taxation and spending. Were the Chancellor to hint at easing of austerity it could act as a cushion to the British economy in these times of slowing growth and therefore be positive for Sterling.
Markets Under-Estimating Political Risks
This cocktail of events could leave the Pound iprone to pronounced political risks.
Analysts at UniCredit Bank say they were expecting a more pronounced decline and the resilience by the British Pound against the Euro and Dollar does put their negative view on Sterling view into question.
However, they are sticking to their guns and expect the Pound to decline.
“We believe that the market is currently underpricing political and economic risks and would advise positioning for GBP depreciation, especially against the Euro,” say UniCredit.
Analysts argue that with the formal EU negotiations starting today and investors having already raised their hopes for a soft Brexit, the currency is more likely to find itself prone to negative headlines and downside risk.
UniCredit think the recent developments in UK bond markets are rather difficult to square with political and economic dynamics at home.
Yields on bonds are a key driver of the Pound; when they head higher the Pound follows.
Nominal yields have held up well since the election.
“With the economy heading for a significant squeeze in real incomes, we think it will not be too long before UK real yields resume their descent, putting pressure on sterling, especially against the euro, which remains underpinned by both economic dynamics and political developments,” say UniCreidt.
