Pound-Euro Recovery Extends as Markets Turn Blue and Bank Stands Pat

- Markets turn higher
- GBP responds positive to improved investor sentiment
- Bank of England keeps rates unchanged
- However, GBP vulnerable to deterioration in investor sentiment

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- GBP/EUR spot rate at time of writing: 1.0955
- Bank transfer rates (indicative): 1.0670-1.0750
- FX transfer rates (indicative): 1.0830-1.0860 >> More information

The British Pound advanced against the Euro on Thursday alongside a lift in global equity markets, as investors bet that global central banks and governments had done enough to minimise the negative economic impact of the coronavirus outbreak.

The Pound-to-Euro exchange rate rallied to 1.0959, as Sterling looks to carve out a base following a month of almost unanswered declines:

The move higher in Sterling echoes a move higher in global stock markets, confirming the currency continues to enjoy a positive correlation with broader investor sentiment. The FTSE 100 has advanced a percent over the course of the day, having started the day in the red; we can see similar patterns of decline and attempts to form a base as is the case with the Pound:

The Pound is particularly sensitive to investor sentiment as it derives a significant degree of valuation from the flow of international investor capital into the UK's economy and markets.

Further aiding Sterling's advance was the decision by the Bank of England to leave interest rates and levels of quantitative easing unchanged at their scheduled March 26 meeting.

The decision was expected, considering that the Bank has already unleashed a sizeable support package for the economy via the decision to cut interest rates to the bone at 0.10% and inject an additional £200bn into the economy via its quantitive easing programme.

The key message from the Bank at today's meeting is however that it stands ready to act by increasing its quantitative easing programme, if need be.

In its entirety, the event offers little by way of fresh information for markets and the direct impact on Sterling will be negligible.

However, that the Bank is fast running out of firepower removes a potential headwind to the currency in the future. The Pound tends to fall in anticipation of interest rate cuts and quantitative easing; remove that threat and a key driver of downside disappears.

"The liquidity crisis doesn't seem to be worsening for the time being, the USD is losing further ground. The GBP may well continue to benefit from the improved situation, especially since the Bank of England didn't deliver any special surprises," says Marc André Fongern, Head of FX Spot & Options at Fongern Global Forex.

While the Pound and global markets are advancing, they will only do so provided the coronavirus narrative does not take a turn for the worst.

It appears that currently markets are trading on the adrenaline pumped into the global financial system by central banks and governments, but remove that and we still have coronavirus cases rising across developed markets and the full extent of the economic damage remains impossible to quantify.

At what point do the fumes from central banks evaporate and the reality that a medical crisis cannot be cured by bankers set in?

We remain wary of such a development and would expect Sterling to come under pressure once more should it materialise.

The risk of Pound Sterling falling to parity against the Euro is considered to be high by foreign exchange analysts at Nordea Markets, one of Europe's major lenders and investment banks.

"While it may seem like there is a long way up to 1.00, we would still not rule out that scenario," says Morten Lund, US & UK analyst at Nordea Markets.

Lund says there are three reasons in particular as to why Sterling is susceptible to further losses.

The first reason is that the UK runs a current account deficit, this is a result of the country importing more than it exports. Typically a currency would fall until such a time as imports and exports reached equilibrium. However, Sterling has over the years traded above this equilibrium point, propped up by significant capital inflows from global investors attracted to UK assets.

"A constant capital inflow is therefore needed to underpin the GBP which is challenging in the present dash for cash situation," says Lund.

A second reason for Sterling vulnerability lies with the country's outsized banking sector: "the UK has a large and systemically important banking sector which is particularly exposed in times of credit crunches and disturbances in the global funding system - containing Libor-OIS and basis swaps spreads via more USD liquidity is key," says Lund.

Thirdly, the analyst believes Brexit has left Sterling exposed to investor fright. "After years of Brexit uncertainty and low returns, the Sterling has lost some of its appeal as a major reserve currency," says Lund.

A fair value model run by Nordea Markets shows EUR/GBP should trade around 0.96, which gives a GBP/EUR rate at 1.0416.

The lowest point reached by GBP/EUR occurred during the last period of serious global investor fright which followed the financial crisis in 2008, when the exchange rate fell to 1.0203.

"But the risk of parity is high," says Lund. "We do not think we have seen the highs in EUR/GBP yet."