Pound Sterling's Recovery Against the Euro Cannot Last says Investment Bank Analyst

- GBP/EUR reverses recent gains
- Crédit Agricole see more losses ahead
- Bank of England and Brexit are two key headwinds

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• GBP/EUR spot exchange rate at time of writing: 1.1180
• Bank transfer rates (indicative guide): 1.0890-1.0970
• FX specialist provider rates (indicative guide): 1.1000-1.1080
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The British Pound's recent bounce against the Euro looks to be over with the gains seen in the first half of this week rolling over and giving way to a familiar trend of weakness which could extend below 1.09 over coming weeks, according to analysis from investment bank Crédit Agricole CIB.

The Pound-to-Euro exchange rate had rallied to 1.1277 on Tuesday, but this proved to be a short-term peak and a mere dead-cat bounce within a broader downtrend. Therefore, based on the recent price action we would be inclined to believe the trend of depreciation that has been in place through the course of May is yet to be snapped.

"Consistent with our FX forecasts, the GBP outlook has worsened sharply on the back of market expectations of further BoE easing (including negative rates) as well as persistent fears about a no-trade-deal Brexit," says Valentin Marinov, Head of G10 FX Research & Strategy at Crédit Agricole CIB.

"The selling pressure should persist in our view," says Marinov.

The Pound has been weakening during the course of May in anticipation of Brexit trade negotiations failing to reach agreement, with a final round of talks being scheduled to end on Friday June 05. Two areas of major disagreement appear to be that of fisheries and to what extent the UK must follow EU rules and regulations and it will take significant compromises on both sides over these issues if a deal is to be reached.

"As to our demands being unreasonable, these are our demands. No qualification UK can put to them will change our demands. We need to find space for compromise loyal to mandate of EU - that’s the challenge that lies ahead of us," said Stefaan de Rynck, advisor to the EU Chief Negotiator, told an Institute for Government event last Friday.

Heading into the new week markets had already priced into the Pound expectations for this final round of negotiations to end in disagreement, as a result the Brexit saga was losing its gravitational pull we argued in a report yesterday and this was one reason why the Pound might have rallied strongly on Monday and Tuesday.

Furthermore, we reported that Prime Minister Boris Johnson was due to meet the European Council President Ursula von der Leyen at some point in June to try and give negotiations fresh momentum. Therefore, with no real sense that the talks will fail in June - indeed we expect further rounds of negotiations to be announced - the Pound does have room too to breath.

But just because Brexit is not crushing Sterling, it is by no means offers a constructive narrative that the Pound can thrive off, therefore the Pound is liable to see any strength as being short lived and a gradual weakening is possible.

Another factor to consider says Marinov is the Bank of England, where policy decisions are proving to be a headwind that will keep the Pound under pressure.

"Especially if the BoE acts more decisively by expanding its QE programme more aggressively," says Marinov.

Above image courtesy of Crédit Agricole.

The Bank of England has cut interest rates to 0.1% in order to support the economy in the face of the covid-19 crisis that has seen activity plummet at its fastest and deepest rate since the 1930s.

While lowering rates can be supportive of the economy it tends to be negative for the value of Sterling, with many analysts arguing that yet deeper cuts to below 0 in the Bank's interest rate will serve as a major headwind to the currency.

"A confirmation of the above risks could see the GBP extending its slide and thus pose some downside/upside risks to our current view," says Marinov.

Crédit Agricole do however see the potential for some recovery in Sterling during the second half of 2020, but this is contingent on the Bank of England not slashing interest rates any further.

That recovery is also contingent on the EU and UK agreeing to extend the Brexit transition period into 2021, "the GBP could face further losses if these views are not confirmed," says Marinov.

It does appear that the Bank of England is rowing back from the idea of slashing rates into negative, with the Bank's Chief Economist Andy Haldane saying last week that such an outcome was by no means set in stone. Haldane argued the economy had reached its nadir and he said a recovery could already be shaping up, thereby weakening the argument for further rates cuts.

However, the prospect of the EU and UK agreeing to extend Brexit negotiations into 2021 appears to be highly unlikely given the UK Government has made extending negotiations an absolute red line they will not cross.

In fact, the law states that "no minister of the crown" can seek to extend negotiations, suggesting there will need to be significant legislative work on behalf of the UK to agree an extension, something the government will be in little mood to countenance.

Crédit Agricole fair value analysis suggests that GBP/USD exchange rate could slip to 1.20 or lower and EUR/GBP could rise to 0.92 or higher if no-trade-deal Brexit risks escalate in the coming months.

EUR/GBP at 0.92 gives a GBP/EUR exchange rate forecast of 1.0870.