Investment Banks Back Euro to go Higher against Pound Sterling

• ING raise EUR/GBP forecasts
• MUFG hold tactical buy on EUR/GBP
• Crédit Agricole says EUR to benefit from ECB policy shift

Image © Pound Sterling Live

The Bank of England's May policy meeting prompted a sizeable fall in the value of the Pound as well as a shift amongst currency analysts, who are now anticipating further weakness in the UK currency.

Foreign exchange analysts at ING have raised their forecasts for the Euro-Pound exchange rate while also warning that risks to this view are to the upside.

Foreign exchange strategists at investment bank MUFG meanwhile say they hold a tactical recommendation to be 'long' on EUR/GBP, anticipating further gains by the Euro against Sterling.

"We were recently short GBP versus the US dollar and that trade hit our take profit level but we feel we should still be short GBP and this time have chosen the euro as the currency to go long," says Derek Halpenny, Heat of Research for Global Markets EMEA at MUFG in London.

Analysts have firmed expectations for Sterling underperformance in the wake of the Bank of England's May update at which interest rates were raised to 1.0% but a soft set of economic forecasts spooked markets.

Sterling fell sharply after the Bank said UK economic growth was set to slow sharply in 2022 and 2023 in the wake of a surge in inflation, which could go as high as 10% later in the year.

But forecasts for inflation to fall back to 2.0% over the longer term signalled to markets the Bank of England might be ready to pause interest rate hikes, denying the Pound a crucial leg of support.

"The May BoE rate meeting was the catalyst for EUR/GBP breaking this year’s trading range to the upside," says Chris Turner, Global Head of Markets at ING Bank.

The Euro-Pound exchange rate rose 1.45% on the day of the Bank's policy update to breach 0.85 and has continued higher since.

This saw a corresponding fall in the Pound-Euro exchange rate below 1.1750, a level it has not closed below since December 2021. (Set your FX rate alert here).

MUFG's Halpenny says the BoE's policy meeting made it "very clear that we are close to pausing which was signalled by the grim forecasts for GDP."

Bank of England forecasts showed that were interest rates to be paused at the current 1.0% inflation would still fall back to near target at 2.16% over a three year time horizon.

"This is a clear signal of being close to pausing," says Halpenny.

ING's Turner says going forward the Pound will be sensitive to negative economic data, particularly wages and consumption.

Confirmation that the UK economy is heading in the direction the Bank of England expects could underpin the recent trajectory lower in the value of Sterling.

However, better than expected outcomes could offer some relief.

"For the UK, the focus will be on how high inflation rises," says Turner. "GBP will be even more sensitive to hard data on consumption as well as wage growth."

The Euro could meanwhile benefit from a change of stance at the European Central Bank (ECB) that suggests it could now welcome a stronger exchange rate.

The ECB has long favoured a weaker Euro given this boosts the Eurozone's export competitiveness while at the same time being inflationary.

But fast forward to 2022 and inflation of the kind the Eurozone is witnessing is not welcomed, given the acute cost pressures on imported energy and commodities.

Analysts are therefore of the view the ECB would welcome a stronger Euro to dampen imported inflationary pressures and could shift policy stance to engineer such an outcome.

"If the ECB want a firmer euro, EUR/GBP will have to rise given the large GBP weight in the euro trade-weighted basket," says Turner.

The ECB looks keen to raise interest rates as soon as July in the face of rising inflation, with some members of the Governing Council seeing a crucial window opening up in which to act.

Above: Market expectations for ECB rate hikes have risen of late. Image courtesy of Goldman Sachs.

Hikes would be supportive of Euro exchange rates, say analysts.

"The removal of negative rates in the Eurozone could be positive for the EUR," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole. "The removal of negative rates in particular can have a positive impact on the single currency for a number of reasons".

Reasons include boosting the profitability of Eurozone banks, the unwinding of EUR carry trades, repatriation of earnings from abroad and an improved appeal in holding Euro cash deposits.

Crédit Agricole have however said their models are suggesting the Pound is oversold relative to the Euro near-term and accordingly anticipate a near-term recovery.

But ING have this week upgraded their end-year EUR/GBP target to 0.86 from 0.84 and keep their end-year 2023 target at 0.88.

"There are probably upside risks to both," says Turner.

EUR/GBP at 0.86 gives a Pound to Euro exchange rate target of 1.1628, down from 1.19 previously. 0.83 EUR/GBP translates into 1.2050.

MUFG are meanwhile targeting a rise in EUR/GBP to 0.88, giving a fall in GBP/EUR to 1.1364.