Pound Euro Exchange Rate FORECAST: GBP-EUR Could Head Towards 1.33 But Concerns Rise That Sterling is Overheating

At the time of writing the pound sterling to euro exchange rate is at 1.2572, the pair is at the best exchange rate levels seen in 22 months.

Sterling has pushed to six-year highs against the US dollar as better than expected manufacturing and construction data cements the belief that UK interest rates will increase sooner rather than later.

"These new levels could provide a good opportunity for businesses to lock in an excellent budget price for the year ahead. Meanwhile sterling buyers may wish to consider the future impact this will have on their profit margins," says Carl Hasty at Smart Currency Business.

Greg Anderson at BMO Capital warns that the GBP may be over-extended at this time:

"The move in GBPUSD represents a new cycle high but the fact that shockingly good data can’t take GBP higher may be a sign that the market can’t get much longer."

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Why is sterling stronger?

UK PMI Manufacturing came in at 57.5 versus 56.7 eyed as all the key components showed improvement while the employment index in the same report rose 55.8 from 54.4 the month prior and new orders rose to 61.1 from 59.5.

As analysts as Markit noted, "UK manufacturing continued to flourish in June, rounding off one of the best quarters for the sector over the past two decades. With levels of production surging higher, and order books swollen by a further upswing in demand from both domestic and overseas clients, job creation accelerated to its highest for over three years."

The euro has thus far avoided a major sell-off following news that Eurozone inflation remains week.

On Monday morning Consumer Price Index (YoY) (Jun) was released at 0.5%, markets had predicted a reading of 0.6%.

Deflation remains a significant issue for Eurozone policy makers and we are surprised that the impact on the euro has not been more sizeable.

"This week’s ECB meeting is likely to be something of a non-event after Draghi pretty much emptied the ammo box last month. Today is also end of month and end of half year, and while in general our model suggests little impact from these flows, there should be a mild EUR positive bias," says a morning forecast note from Lloyds Bank Research.

Pound euro forecast: Can theGBP/EUR run higher?

The market is heavily long on the pound, particularly against the euro.

Sean Lee at FXWW says we can make an argument either way here; perhaps the market has plenty of scope to decrease longs as there are so few positions elsewhere, or the lack of general momentum will cause the longs to run for cover soon which could see a further fall in the rate.

"I’m still of the view that we are headed to .75 but the ‘easy’ money has been made in the move from .85 to .80 and now that the move is more mature, we are likely to see more of a grind lower with plenty of profit taking rallies along the way," comments Lee on the EUR/GBP.

In "GBP to EUR" terms 0.75 is 1.33.

Outlook for the GBP this week

We have the UK PMI series to look forward to this coming week, and any gains in the GBP will require the data to come in above expectation.

Tuesday: UK manufacturing PMI (June), 9.30am: UK manufacturing is expected to weaken to 56.5 from 57 in May. Market to watch: EUR/USD, EUR/GBP

Wednesday: UK construction PMI (June), 9.30am: Construction forms only a small part of the UK economy, so this index's importance is limited. It is expected to weaken to 59.8 from 60. Market to watch: EUR/USD, EUR/GBP

Thursday: UK composite & services PMI (June), 9.30am: The services PMI is the most important of the UK readings, and is expected to weaken to 58 from 58.6. Market to watch: EUR/USD, EUR/GBP

According to Steve Woodcock at TradeNext eyes will also be focused on the UK's hot housing market, "Sterling is on hold as high house prices are the current threat. Carney is not worried announcing that the value of GBP should not rely on the housing market."

US dollar under pressure on fresh economic pessimism

The USD has meanwhile weakened the most in almost a quarter as signs stateside signalled that economic growth is flagging and speculation that the Fed might raise interest rates sooner than anticipated dampened.

"Cable headed for its longest run of quarterly gains versus the dollar since 2007 as growth in the UK boosted the case for a jump in interest rates. The US economy added 215,000 jobs in June, about the same as in May, a report is forecast to show. The USD dropped 0.6% to 101.42 yen and touched 101.32, the lowest since May 21st . It has fallen 0.3% this month, dropped 1.8% this quarter and lost 3.7% this year against the Japanese currency," says a currency note issued by AFEX.