Time to Buy Pound Sterling and Sell the Euro say Strategists
Above: ECB President Mario Draghi at the ECB's forum in Sintra, Portgual. ECB policy is one reason why the Euro could underperform Sterling going forward say currency strategists. Image (C) European Central Bank.
Foreign exchange strategists at Westpac - the Sydney-based global investment bank - have told clients the Pound could now well be due a recovery against the Euro, recommending clients sell the EUR/GBP exchange rate.
The call is based on five observations:
1) ECB Policy Getting 'Easier'
European Central Bank (ECB) President Mario Draghi on Tuesday opened the door to further interest rate cuts or further quantitative easing, a move that ultimately undermines the Euro.
The Pound-to-Euro exchange rate was under pressure ahead of Draghi's address to the central banking forum in Sintra, Portugal, but rallied sharply when he told his audience that the Bank was preparing to ease policy once more.
The GBP/EUR exchange rate trades at 1.1220 on Wednesday, having been as low as 1.1139 the day prior.
Textbook foreign exhcange theory states that when a central bank prints more money (quantitative easing), or cuts interest rates, its currency falls as the supply of currency to the economy increases.
Faced with stagnant growth in the Eurozone, and falling inflation expectations, the ECB will feel they have little other options but to keep pumping money into the Eurozone economy to keep it moving forward.
2) German Data isn't Improving
With the Eurozone economy in mind, the call by Westpac to buy Sterling against the Euro comes amidst signs that the economic slowdown in Germany lingers.
The ZEW indicator of economic sentiment fell to minus 21.1 this month, dropping 19 points from May and well below expectations of minus 5.9 in a Reuters poll.
"The fall in ZEW expectations indices signal risks of a pullback from tentative rebounds in Eurozone activity," says Westpac.
ZEW is a key gauge of expectations for the German economy plummeted in June, as trade fears, geopolitical tensions and Brexit all weighed on financial executives.
“The sharp drop in the ZEW Indicator of Economic Sentiment coincides with an increased uncertainty regarding the future development of the global economy and substantially worsened figures for the German economy at the beginning of the second quarter,” said Achim Wambach, president of ZEW.
3) Trump Turns his Guns on Europe
U.S. President Donald Trump yesterday released a series of quite remarkable tweets in response to the Draghi's announcement that the ECB would be looking to ease monetary policy further.
"Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA. They have been getting away with this for years, along with China and others," said Trump.
We see this as Trump potentially positioning himself for a tariff assault on Europe, eyeing their sizeable trade surplus with the U.S.
The U.S. would likely start such an assault by imposing tariffs on European car imports, which would in turn pose another sizeable headache for the Eurozone's economy and only adds to uncertainty for the Euro's outlook.
"Europe now risks being the target of Trump’s trade tariff diplomacy," says Westpac.
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4) Boris is 'in the price' of Sterling
UK domestic politics are widely credited as having been behind the British Pound's large fall since early May.
The failure of Prime Minister Theresa May's Brexit bill to pass through parliament, her resignation and subsequent fears that the next Prime Minister would tow a tougher line on Brexit have all transpired against the Pound.
But with Boris Johnson the overwhelming favourite to replace May for some time now, we are struggling to buy the view that the Pound continues to fall because of the Boris factor.
We know he is incoming, and we know he wants to renegotiate the Brexit deal and is committed to leaving the EU at the end of October if the EU fail to renegotiate.
"Markets have priced in the potential of Boris Johnson as a more hard Brexit PM and even risk of a no-deal exit," says Westpac.
In short, the Pound is running low on reasons to fall in the short-term.
5) The Bank of England Could Provide Support
The ECB have signalled they intend to cut interest rates, and the Euro fell.
The U.S. Federal Reserve could well cut their interest rate at tonight's meeting, or at least follow the ECB's footsteps and signal interest rate cuts are coming. This should place a lid on the U.S. Dollar, or even encourage some declines.
Meanwhile, the Bank of England meets on Thursday and is it is universally expected that there will be no such 'dovish' overtures coming from the BoE as they eye the UK's improving wage growth data and robust inflation dynamics.
This leave the BoE looking to be the most 'hawkish' of the three, which according to textbook currency theory work in favour of Sterling.
Other analysts agree on this point.
"BoE policymakers still maintain their hawkish bias, favoring rising rates at a faster pace than financial markets would consider. It is therefore very likely that the BoE statement or policy minutes from Thursday monetary policy meeting will continue to hint towards further tightening, most likely giving British Pound a boost," says Vincent Mivelaz, an analyst with Swissquote Bank.
Westpac is anticipating a move lower in EUR/GBP to a target of 0.8770, this gives a rise in GBP/EUR to a target of 1.14.
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