GBP/EUR Week Ahead Forecast: That Post-mortem Cat Show Again

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The Pound to Euro exchange rate has recovered the 1.18 level with the help of a spiralling Euro and ousting of another Prime Minister from the Banana Republic of Westminster but the risk is that all of this has merely just scripted Sterling into a rerun of The Post-mortem Cat Show.

Sterling benefited greatly last week when a bottom came out from underneath the single currency, which fell to within a whisker of parity against the Dollar by Friday and helped GBP/EUR to recover above 1.17 along the way.

But a large part of the Pound's subsequent climb to highs of 1.1844 ahead of the weekend was evidently the market response to the resignation of the Prime Minister and there has been lots of commentary to this effect too.

“A key focal area for markets will be the direction of fiscal policy with the Treasury under new management. All Conservative candidates are likely to prioritise two things: tax cuts and a pivot to a smaller state,” says Sanjay Raja, an economist at Deutsche Bank. 

“Indeed, under current OBR projections, the public sector tax-take is set to hit its highest level (as a share of GDP) in 40 years by the middle of the decade. And the size of the public sector workforce has ballooned over the last few years,” Raja also said on Friday.

Above: Pound to Euro rate shown at hourly intervals alongside GBP/USD and EUR/USD. Click image for closer inspection. 

The rub for Sterling, however, is found in the earlier rise of the now-outgoing prime minister and the cautionary tale that it offers to all of those who might be tempted to invest their hopes or ambitions into the politics and practices of banana republics and failed states.

It was, after all, The Palace of Westminster's other recent coup that endowed the country with the now-outgoing prime minister and that too was also partly the result of the last shambolic, if not gerrymandered leadership selection process involving the governing party.

“For all the scandals, it is hard not to see Johnson’s looming departure as being closely linked to Brexit – without it, he probably wouldn’t even have received the keys to 10 Downing Street in the first place,” says Jane Foley, head of FX strategy at Rabobank. 

“Brexit is a beast which has now devoured three prime ministers: first Cameron, then May (who was, understandably, having a jolly good time yesterday) and now Johnson. A fourth prime minister, whoever this might be, will be added to the menu too if the Tories fail to get their act together,” Foley also said on Friday.

There has been a widely articulated view that a changeover of the guard could end the litigious dispute over the Northern Ireland protocol but that thinking sounds like the work of the very same cognitive gremlin who said loudly back in 2016 that the outgoing PM's predecessor would be a 'safe pair of hands.'

Above: Pound to Euro rate shown at daily intervals. Click image for closer inspection. 

This is because so far none of the above has changed the position of the Democratic Unionist Party, which is still protagonistic for having both the UK government and the European Commission completely cornered in relation to what everybody previously knew as the "Northern Ireland backstop."

That explains the most recent Brexit legislation and also potentially ensures that the London:Brussels standoff continues up until "the end of 2024 (four years after the end of the transition period)," or any earlier point at which the European Commission might decide that it just wants to spare its own blushes.

There would almost surely have to be at least some form of blushes too if, after all of the political messaging about 'international law' and 'trust', the commission was to then fall flat through the correct and proper channel that is its very own web of international treaties.

But in the meantime the Bank of England (BoE) is set to continue firing its interest rate off into the air and for Sterling that makes equally as relevant a looming address from the governor, who speaks about the economic landscape at an Official Monetary Institutions Forum (OMFIF) event on Tuesday.

“The consequences for the monetary policy cycle are not trivial,” says Fabrice Montagne, chief UK economist at Barclays, of recent political developments.

Above: GBP/EUR at weekly intervals with 200-week moving-average and Fibonacci retracements of September 2020 recovery indicating possible medium-term technical supports. Click image for closer inspection. 

Montagne and the Barclays team said on Friday that whatever any new prime minister does with the national finances will be an important determinant of the Bank of England interest rate outlook with the most important factor being whether or not there is an increase or decrease in overall spending. 

“In the first scenario (fiscal tightening in 2023), the BoE would not be incentivised to hike any further as the policy mix would become overall restrictive, driven by fiscal considerations. In the second scenario (fiscal spending in 2023), the Bank may be forced to hike further and offset part of the fiscal stimulus, all else equal,” Montagne said.

Sterling may also be likely to pay attention on Wednesday to release of UK GDP data for the month of May and could have a favourable impact if it shows the economy holding up better under the weight of onerous energy prices than is anticipated by the consensus among economists, which envisages 0% growth.

"We agree with the consensus that GDP likely held steady in May, and thus failed to rebound after April’s 0.3% month-to-month decline. The risks, however, are skewed to the downside," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics. 

"We expect May’s data to show that the economic recovery has lost its momentum and does not need cooling through much higher interest rates. We continue to expect the MPC to stick to hiking Bank Rate by 25bp at its next two meetings, and then to stop there," Tombs also said on Monday.

Above: EUR/USD at hourly intervals with Fibonacci extensions of Tuesday slump indicating prospective pivot points.

The week ahead calendar is otherwise devoid of meaningful appointment for Sterling but the Pound to Euro rate is likely to be sensitive to whether or not the single currency can pick itself up off the canvass following a near miss with parity against the U.S. Dollar early on in the London session on Friday.

It may be noteworthy in this regard that the Euro-Dollar rate actually closed higher on Friday after rallying hard from levels that had coincided closely with the 78.6% Fibonacci extension of last Tuesday's big lurch lower.

The 78.6% Fibonacci extension also itself coincides closely with a 100% extrapolation of the January 2021 to November 2021 downtrend.

Meanwhile, Friday's rally left behind in its wake on charts what may be something like a "dragonfly doji" or "hammer" candlestick reversal pattern.

To the extent that any of this indicates a bottom has been struck by the Euro, it would be a further restraining influence on GBP/EUR, which could now struggle to advance much beyond its earlier high of 1.1844 during the week ahead.

Above: Euro-Dollar at weekly intervals with Fibonacci extensions of January-November 2021 slide indicating prospective pivot points.