Pound Sterling Slumps to Fresh 3-month Low against Euro, Warnings of Parity Issued by Analysts

- GBP/EUR in sharp slump over past 24 hours
- Parity warnings sounded by analysts
- But, short-term GBP/EUR now looking oversold

Image © Pound Sterling Live

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The British Pound fell to a fresh three-month low against the Euro amidst a combination of growing anxiety that the UK and EU will fail to agree a comprehensive free-trade agreement by year-end and signs that the Eurozone's economic recovery from the coronacrisis is outpacing that of the UK.

Indeed, there is evidence that the recent decline in the Pound-to-Euro exchange rate to a new multi-week low at 1.0915 is not necessarily down to just Brexit concerns, but also evidence that the Eurozone's economic recovery is outpacing that of the Eurozone.

Markets appear to be increasingly interested in the speed with which economies emerge from the coronacrisis, rewarding the currencies of country's and regions where economic growth is outperforming.

Samuel Tombs, UK Economist at Pantheon Macronomics says there is evidence that the U.K.'s recovery from Covid-19 is lagging behind that of Europe's after the European Commission's Economic Sentiment Indicator (ESI) picked up much less of a recovery in the UK than in the EU in June.

The European Commission's ESI for the UK rose to 65.2 in June, from 61.7 in May; 100 represents the 1990-to-2019 average. But, compare this recovery to that of the Eurozone:

"The pick-up in the ESI in June adds to evidence that the U.K. economy is recovering, albeit at a slower pace than most others in Europe," says Tombs noting the U.K.’s ESI undershot the E.U. average, 74.8, in June by a substantial margin.

Should the the ESI data be reflecting the current underlying performance of the two economies the fundamental conditions for the Euro to outperform Pound Sterling become obvious. International capital chases higher returns and based on the speed of recovery in the UK vs. EU there is a case to be made for a flow of capital from Sterling into Euros.

Over the course of the past 24 hours the Pound-to-Euro exchange rate fell to a 3-week low at 1.0915, but in the process of doing so the sell-off officially reached oversold levels, meaning the prospect of a short-term rebound has grown.

The Relative Strength Index on the daily chart reached 30: a level of 30 or below signals oversold readings and the RSI typically tends to never back into the 30-70 range meaning either consolidation or a rebound takes place.

We would not therefore be surprised to see some short-term Sterling strength at some point this week.

Above: The RSI is located on the lower panel and suggests GBP/EUR is reaching oversold conditions

However, expect any Sterling strength to be short-lived as it appears to be political uncertainty that is providing a fundamental weakness in Sterling that extends beyond just the Pound-to-Euro exchange rate. One factor cited as being behind the latest pulse of Sterling selling is Prime Minister Boris Johnson who over the weekend confirmed to his Polish counterpart that the UK was willing to exit the EU on an Australia-style trade agreement.

This is significant in that an Australia-style trade agreement is ultimately a 'hard Brexit' as the EU and Australia effectively trade on World Trade Organisation terms, which foreign exchange analysts say represents a worst-case outcome from current negotiations for Sterling.

Robert Howard, a market analyst at Thomson Reuters says should the UK and EU only manage an Australia-style deal, the Pound-Euro exchange rate could fall to parity.

"The Pound could drop below 1.00 against the Euro for the first time if Britain exits the European Union on "Australia terms", as this would equate to a hard Brexit," says Howard. "Australia does not have a comprehensive trade agreement with the EU; much of EU-Australia trade follows default World Trade Organisation rules."

The analyst says the fear that the EU and the United Kingdom may be unable to agree a trade deal before year-end helped depress GBP/EUR to a 13-week low of 1.0914 on Monday, with GBP/USD dropping to a one-month low of 1.231.

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The EU and UK on Monday started a more intense round of trade negotiations - that should take place every week in July - aimed at breaking through the current impasse.

The EU's Chief Negotiator last week said the EU would need a deal sealed by October, possibly at an EU Council Summit, which would be expected to lead to a breakthrough.

"The UK government wants to see the outline of a EU-UK trade deal by the end of the summer, the EU is thought to need a deal by October in order to allow time for each member nation to ratify the deal. Investors are becoming nervous about the lack of time available for negotiations, about the prospect of a rushed, bad deal," says Jane Foley, Senior FX Strategist at Rabobank.

Foley says the recent pressure on the Pound would appear to reflect various market commentaries suggesting that a no deal Brexit is still a reasonable prospect.

Foley forecasts further falls in Sterling, not just owing to the political uncertainty posed by Brexit negotiations, but also due to the significant hit to the UK economy from the covid-19 crisis.

"On top of the UK’s political uncertainty, its long covid-19 lockdown and its reliance on the hard hit services sector means significant economic costs. Earlier this month the OECD forecast that the UK will suffer the worst recession in the developed world this year. The BoE has left the prospect of a negative interest rate on the table. Although this is unlikely to be an imminent policy response, the chances of such an outcome would likely increase if a trade deal is not be agreed with the EU and recovery hopes were further undermined," says Foley.

Rabobank tell clients that a combination of negative rates and a current account deficit could leave the Pound particularly exposed to downside pressure.

"Although it is not our central view, this scenario could push EUR/GBP back to the 1.00 area," says Foley.

But Foley says some of the declines in the GBP/EUR exchange rate of late are also a result of improved sentiment towards the Euro thanks to the strong policy response to the coronacrisis by EU officials.

"Some of these gains can be attributed to an improvement in the EUR’s relative fundamentals. Recently the single currency found support from the European Commission’s proposal for a recovery fund for the region which incorporates grants as well as loans," says Foley.

The European Central Bank has meanwhile boosted its support for the Eurozone economy by announcing a bigger than expected expansion of its quantitative easing programme whereby it creates money to buy sovereign and corporate bonds.

Rabobank forecast the GBP/EUR exchange rate to trade towards 1.0870 on a 1 to 3 month view.