Pound-Euro Week Ahead Forecast: Plain Sailing with Upside Risks On Any Renminbi Rally

- GBP/EUR buoyant on signs economy headed for recovery
- Technical analysts eye 1.17 this week & 1.18+ further out
- Calendar quietens but GBP could rise on any PBoC FX shift

Image © Pound Sterling Live

• GBP/EUR reference rates at publication:
• Spot: 1.1616
• Bank transfers (indicative guide): 1.1309-1.1390
• Money transfer specialist rates (indicative): 1.1416-1.1535
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The Pound-to-Euro exchange rate remains underpinned by an economy that is tentatively delivering on bullish market expectations but could receive a further boost in the coming days and weeks if Chinese policymakers go ahead with a possible decision to allow the Renminbi to appreciate against the Dollar.

Pound Sterling ended the week having settled comfortably above 1.16 for the first time since April after being aided on Friday by a rally that came in the wake of Office for National Statistics figures showing retail sales surging last month.

April’s 9.2% sales rise was the largest since the immediate aftermath of the UK’s initial shutdown and an indication that the economy is tentatively on course to deliver a Bank of England (BoE) forecast for 2021 GDP growth that would be Britain’s fastest since 1941.

“April's move to unlock the economy saw a surge in spending, a lot of it on clothes and gasoline. The market wonders if the BOEs MPC will start to get itchy fingers,” says Kit Juckes, chief FX strategist at Societe Generale.

Services and manufacturing PMI surveys from IHS Markit also rose to new highs for the month of May last week, lending further support to expectations of a strong economic rebound as the UK and other economies advance through the reopening process.

These expectations have helped put a supportive wind into the sails of the Pound in recent months and gotten technical analysts looking for the Pound-to-Euro rate to advance further over the coming days and weeks.

“We look for a slide to .8533, the mid-March low,” says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank, referring to EUR/GBP.

Above: Pound-to-Euro exchange rate at daily intervals shown alongside EUR/GBP.

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Jones says the EUR/GBP exchange rate is likely to remain under pressure, potentially making its way back to 0.8533, which would see the Pound-to-Euro rate trading around 1.1719. However, she and the Commerzbank team look for the Pound to rise toward 1.18 over a multi-week horizon.

"The strong UK May PMIs have underlined the optimistic case for the UK economic outlook and it is a clear tailwind for GBP," says Petr Krpata, chief EMEA strategist for FX and interest rates at ING.

The nascent recovery and elevated investor optimism about the outlook for the UK is likely to remain supportive of Sterling, although the elephant in the room for the weeks ahead, or the giant panda to be more precise, is the People’s Bank of China (PBoC) and the implications of a possible change to its foreign exchange policy.

This is after Lu Jinzhong, head of research at the Shanghai branch of the PBoC, was reported on Friday to have outlined in one of the bank’s magazines how the PBoC could use its administrative influence on the USD/CNH exchange rate to address the adverse impact that rising commodity prices have had on domestic companies.

“If this is a trial balloon floated by the PBoC, then we should all be watching USD/CNY and the offshore USD/CNH a little more closely,” says Chris Turner, regional head of research at ING and colleague of Krpata’s.

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Many commodity prices have risen by double-digit percentages in the last year and in the process have raised costs for producers who pay in Renminbi or other currencies, which is squeezing profit margins and threatening to stoke inflation for more than just companies.

These side effects are a speed bump for China’s economic recovery and one which Jinzhong suggested on Friday that the bank should attempt to address by allowing or otherwise encouraging the Yuan to appreciate against the U.S. Dollar in a policy change that would likely be supportive of many currencies including the Pound and Euro.

“Let’s see whether USD/CNY can break under the 6.40/41 area over coming weeks (we do in general like a soft dollar environment this summer) and in general, broad trends in USD/Asia – particularly in USD/CNY – do tend to support the overall USD trend,” Turner says.

A stronger Yuan exchange rate would make Dollar-denominated commodity prices more affordable for Chinese buyers but would also for those elsewhere if recent correlations are to hold, given that many other currencies often move alongside the Renminbi.

As can be seen from the below graph the main Sterling exchange rate GBP/USD, which is an important influence on GBP/EUR, has recently had a very positive relationship with the Renminbi (green line) and more so than has been the case for EUR/USD.

The latter could be indicative of upside risks for the Pound-to-Euro rate in the event of any rally by the Renminbi this week or thereafter.

Above: GBP/USD shown alongside CNH/USD (green), USD/CNH (purple) and GBP/EUR (blue).