Pound-to-Euro Rate Tipped as a Buy as Budget Set to Prompt UK Growth Outperformance

- GBP/EUR tipped as a buy at Societe Generale ahead of budget.

- Budget to lift investment spending by £100 bn over this parliament.

- Higher spending to widen gap betwen UK-EU growth expectations.

- And lift GBP/EUR as EUR economy hamstrung by fiscal straitjacket.

- GBP/EUR seen averaging 1.1767 this year, implying 1.14-1.21 range.

- Budget may inspire GBP bounce from range lows on strong stimulus.

Image © Gov.uk

- GBP/EUR Spot rate: 1.1411,  up +0.05% today

- Indicative bank rates for transfers:  1.1116-1.1196

- Transfer specialist indicative rates: 1.1245-1.1313 >> Get your quote now

The Pound is tipped to rise against the Euro in the coming months and has been labelled as a buy at Societe Generale ahead of Wednesday’s budget, which is expected to yield a sharp increase in public sector spending that could help the economy to outgrow its continental rival in the years ahead.

Chancellor Rishi Sunak will set out the government’s eagerly-awaited spending plan for 2020 and beyond at 11:30 Wednesday and markets have been primed to expect an investment program that lifts economic growth in poorer northern parliamentary seats, some of which voted for the Conservative Party for the first time in decades last year. 

The update will come as Sterling digests a surprise and unscheduled decision by the Bank of England to cut Bank Rate to its all-time low of 0.25%, alongside other measures in a bid to support the economy through a possible slowdown brought on by efforts to contain the coronavirus that has infected more than 300 in the UK including a government health minister. The government itself is also expected to use the budget to offer support to companies and households affected by the virus. 

“What to trade amidst the volatility? Short EUR/GBP appeals, and the two charts below show why. The first shows the currency and the average relative growth expectations, using Bloomberg consensus from 2017 to 2021. The decoupling of the currency from growth came as we started to really fear a no-deal Brexit and we will go on getting some of that in the months ahead,” says Kit Juckes, chief FX strategist at Societe Generale. 

Above: Societe General graph showing EUR/GBP with UK- EU differential in growth expectations and bond yields (right)

ITV News has reported that the Government will lift investment spending by £100bn, which is equivalent to around 5% of GDP and will take the total budget for public investment near to £500 bn for the current parliament, according to ITV. The money is intended for roads, railways, broadband, flood defences although no specific project announcements are to be announced on the day. Some of those could be set out in subsequent weeks, although many might have to wait until the July spending review.

Wednesday’s budget could lift public sector net investment back to levels considered normal in some other countries but which have not been seen in the UK since the early 1970’s. And that would be good for the UK’s medium-term growth prospects given investment is thought to have the highest ‘fiscal multiplier’, with every one Pound spend then adding that amount or more directly to GDP, whereas a Pound spent on day-to-day items or welfare is thought to add less than that to GDP.

Economic growth matters greatly to currencies and the bilateral difference between growth rates is an important driver of exchange rates because it impacts market expectations for inflation as well as interest rates in subsequent years. The UK-Eurozone growth differential has shifted in favour of Sterling in the last year , as the Eurozone economy has slowed more sharply than the UK’s, and Societe Generale’s Juckes sees it widening further in the years ahead as a result of a budget boost to UK GDP.

The UK economy grew by 1.4% in 2019 but slowed sharply heading into year-end while the Eurozone economy grew 1.2% after almost grinding to a halt in the final quarter as Italy, France, Greece and Finland saw their economies contract and Germany stalled.

“[The] Budget is an opportunity to highlight a more proactive fiscal policy than seems possible on the other side of the channel,” Juckes says. 

Above: Pound-to-Euro rate shown at daily intervals.

And while the UK benefits from an expansionary budget this year, much of the Eurozone will be hamstrung by the bloc’s fiscal rules.

European Union members are subject to the stability and growth pact terms contained in the treaties although the rules are enforced more stringently for Eurozone countries, some of whom are now bound by treaty to progressively reduce their deficits each year. That rules out fiscal support for those countries at a time when many have seen their economies slow due to the U.S.-China trade war, Brexit uncertainty and other factors.

A widening growth differential could condemn the EUR/GBP rate to trading under a wider and more Sterling favourable growth differential that will be positive for the Pound-to-Euro rate. Juckes forecasts the Pound should average 1.1764 this year partly as a result of the growth differential which, when combined with Wednesday’s 1.14 level of the Pound-to-Euro rate, implies a rough 1.14-to-1.21 range for the year. 

“We still see EUR/GBP averaging 0.85 this year, torn between fears about trade negotiations and relative economic optimism,” Juckes writes in a research note.

Sterling was at the bottom of that 1.14-to-1.21 range range Wednesday after falling more than 5% since mid-February, with the Euro having been strengthened by the coronavirus meltdown even though its own economy is among the most exposed after China to the economic fallout from the viral pneumonia’s transmission to more than half the world’s countries. 

But Wednesday’s budget could be a catalyst for a bounce in Sterling if government spending commitments lead to a reappraisal of UK growth prospects, although much about the outlook also now depends on the pace at which the virus spreads in Europe and the lengths governments will go to in order to contain it. Economies are facing disruption from containment practices like the nationwide restrictions on the movement of people in Italy.