Pound Sterling Set for Worst Week against Euro Since March Coronacrisis Slump

- GBP in 3.4% fall this week alone
- EU sets UK an ultimatum
- But trade negotiation talks set to continue next week

Image: Prime Minister Boris Johnson. Picture by Pippa Fowles / No 10 Downing Street

• GBP/EUR spot rate at time of publication: 1.0836
• Bank transfer rates (indicative guide): 1.0557-1.0633
• Specialist transfer rates (indicative guide): 1.0670-1.0740
• More information on specialist rates, here

The British Pound has endured its deepest declines against the Euro since March owing to a combination of an ECB-inspired rally in the Euro exchange rate complex and a sharp deterioration in sentiment surrounding Brexit trade negotiations that has left markets to raise expectations for a 'no deal' outcome.

The Pound-to-Euro exchange rate has fallen 3.42% this week which takes it back to mid-March lows meaning that months of gains have unraveled in less than five days. The last time the Pound was this weak was when global markets were in a panic regarding the spread of the covid-19 crisis and mid-August 2019 when market expectations for a 'no deal' Brexit were particularly elevated.

GBP/EUR is quoted at 1.0838 ahead of the weekend having fallen a substantial 1.55% the day prior which is the exchange rate's worst day since March 18.

Above: GBP/EUR weekly chart

Sterling fell against the majority of its peers on Thursday as markets ramped up their expectations for a 'no deal' outcome to Brexit trade negotiations after the EU gave the UK an ultimatum to drop plans to pass a law it views as controversial.

The European Commission said on Thursday the EU would give the UK until the end of September to withdraw legislation that it says seeks to undermine the Withdrawal Agreement reached between the two sides in 2019.

If the UK fails to drop the legislation, or retract the offending elements of the legislation, the EU would take legal action. We reported yesterday that there was an interpretation by some commentators that this amounted to calling off Brexit negotiations, however it is unclear whether that is in fact the case given that the EU and UK negotiating teams have agreed to continue talks next week.

The ulimatum was laid down after European Commission Vice-President Maroš Šefčovič attended an extraordinary meeting of the EU-UK Joint Committee in London on Thursday to discuss the UK government's draft publication of the “United Kingdom Internal Market Bill”. Following the meeting the Commission said existing clauses in the Bill that relate to Northern Ireland would break "a legal obligation" if passed.

"The EU does not accept the argument that the aim of the draft Bill is to protect the Good Friday (Belfast) Agreement. In fact, it is of the view that it does the opposite," read a statement released by the EU Commission.

Šefčovič requested the UK government to withdraw the offending measures contained in the draft Bill in the shortest time possible "and in any case by the end of the month". If not, "the European Union will not be shy in using" "a number of mechanisms and legal remedies to address violations of the legal obligations contained in the text".

The Times outline the shape of what such sanctions might look like, reporting on Friday "Brussels has threatened Britain with financial, agricultural and trade sanctions if ministers refuse to back down on their threat to walk away from parts of the withdrawal agreement. In a provocative move Michel Barnier, the EU’s chief negotiator, hinted that it could ban imports of British food and livestock when the transition period finished at the end of the year."

Despite the EU's position, the UK Prime Minister Boris Johnson appears to be steadfast in its resolve to pass the Internal Market Bill, even in the face of strong opposition amongst Conservative MPs and the House of Lords.

"Parliament is sovereign as a matter of domestic law and can pass legislation which is in breach of the UK’s Treaty obligations. Parliament would not be acting unconstitutionally in enacting such legislation," said the UK Government in a statement. "This ‘dualist’ approach is shared by other, similar legal systems such as Canada, Australia and New Zealand. Under this approach, treaty obligations only become binding to the extent that they are enshrined in domestic legislation."

With political tensions rising again foreign exchange analysts are warning of further downside in the UK currency.

"The EU has given the UK until the end of September to amend the Bill. If the UK does not comply, the negotiation efforts between the two economies will be jeopardised. The risk of a no‑deal Brexit is becoming increasingly likely and remains a major weight on GBP," says Carol Kong, a foreign exchange strategist with CBA.

Trade negotiations are however set to continue next week in Brussels, serving as a reminder that there remains a chance that a Brexit trade deal is ultimately reached and what we are witnessing at present is the typical - albeit high stakes - posturing that preceeds a deal being agreed, a view which should offer a limit to the Pound's downside.

"We remain committed to working hard to reach agreement by the middle of October, as the Prime Minister set out earlier this week," said UK Chief Negotiator David Frost, in a statement following the 7th round of talks that concluded in London on Thursday. "We have agreed to meet again, as planned, in Brussels next week to continue discussions."

Euro Surges

ECB President Christine Lagarde explained the Governing Council's monetary policy decisions and answered questions from journalists at the Governing Council press conference held on 10 September 2020 at 14:30 CEST in Frankfurt am Main. Photo by Sanziana Perju / European Central Bank.

But it was not just Sterling weakness that drove the GBP/EUR exchange rate lower over the past 24 hours, a genuine bout of Euro strength was recorded in the wake of the European Central Bank's September meeting that ensured the Eurozone's single currency went higher right across the board and remains favoured to extend gains.

The Euro went higher after the ECB failed to push back on a stronger Euro, which has been rising since March, with ECB President Christine Lagarde saying that while gains had been "extensively discussed" by the Governing Council it does not target the exchange rate.

"Lagarde’s decision to push back on claims that the euro is overvalued ultimately sparked a predictable rise for the single currency," says Joshua Mahony, Senior Market Analyst at IG.

The comments were made in a briefing during its September policy event and signalled to markets that the currency can move higher before the ECB expresses discomfort and considers taking action, thereby removing a potential impediment to the extension of its 2020 rally.

The Euro had retreated on September 01 when the ECB's Chief Economist Philip Lane spooked traders after saying the Euro exchange rate does in fact matter, the comments coming on a day the EUR/USD hit the 1.20 milestone.

Adding to the positive sentiment was the ECB's upgrading of growth and inflation forecasts for the Eurozone economy; they now see Eurozone GDP contracting 8.0% in 2020 whereas the decline was seen at 8.7% in June projections.

Growth is now seen at 5.0% in 2021 (previously 5.2%) and at 3.2% in 2020 (3.3% previously).

Inflation forecasts show the ECB still sees prices rising at 0.3% in 2020, which is a forecast unchanged on June.

However, inflation for 2021 is raised to 1.0% from 0.8% previously, a bullish development for the Euro.

2022 inflation is seen unchanged at 1.3%.

"ECB Governor Lagarde seemed quite confident in the prospects of a solid economic recovery, and did not seem very worried about the recent dip in inflation. This supports our baseline forecast, namely that the policies are likely to remain unchanged throughout the next year. We do still acknowledge a significant risk of further easing measures, particularly in the events of financial turbulence or a continued strong appreciation of the euro," says Kjersti Haugland, an economist at DNB Bank.

Following the developments the Euro-to-Dollar exchange rate was quoted 0.75% higher at 1.1889, the Euro-to-Pound exchange rate 0.86% higher at 0.9159 and the Euro-to-Australian Dollar exchange rate 0.50% higher at 1.6297.