GBPEUR Strength Forecast But Eurozone Inflation Data Prompts Euro Recovery

Above: A busy week of data releases for GBP got off to a good start with Manufacturing PMI beating predictions.

The outlook for the British pound to euro exchange rate (GBP/EUR) is forecast to retain its well-established positive bias this March.

However, the month has gotten off to a soft start for the pound sterling despite the release of some strong UK economic data. Manufacturing PMI beat expectations - but to no avail for sterling bulls.

Nevertheless, the trend remains in favour of the UK unit:

“EURGBP has depreciated almost 3% over the past month, potentially reflecting increased safe-haven demand for GBP assets as euro area political uncertainty remains high and as euro area government bonds offer increasingly unattractive, and often negative, yields,” say Barclays in a weekly forecast note issued to clients.

At the time of writing we see the pound to euro exchange rate trading lower by a quarter of a percent. 1 GBP = 1.3815 EUR.

The euro to pound converts at 1 EUR = 0.7240.

NB: The above quotes and graphic representations are taken off the wholesale markets. Your bank will affix a spread at their discretion when passing on currency. However, an independent FX provider will seek to undercut your bank's offer, thereby delivering up to 5% more currency in some instances. Find out more.

Euro Exchange Rates Boosted by Deflation Data

The euro is currently staging a strong recovery rally against the pound, dollar and other majors. The downtrodden currency saw solid relief buying sparked by the release of better than expected inflation data.

Eurozone inflation rebounded in February with the annual cost of living standing at -0.3%, up from -0.6% in January, the EU statistics agency Eurostat said in preliminary data.

Markets had expected a reading of -0.5%; the positive surprise got the shared currency off to a strong start.

While this is not a game-changed for the European Central Bank currency markets will be particularly prone to positive data surprises in the Eurozone owing to the overwhelmingly negative stance taken against the shared currency.

Manufacturing PMI at 7 Month High

The pound sterling entered the new week, and month, on the defensive as both the dollar and euro found support.

However, the GBP is still expected to enjoy a positive tone in coming days, provided data does not disappoint.

“Further improvements in UK activity indicators this week should support continued GBP outperformance,” say Barclays at the start of what should be a busy week for the UK currency.

The seasonally adjusted Markit/CIPS Purchasing Manager’s Index® (PMI® ) rose to a seven-month high of 54.1 in February, up from 53.1 in January.

Markets had expected a reading of 53.4 indicating this is a pro-GBP outcome.

The pound sterling found a fresh bid on the back of the day however a substantial rally has failed to materialise which tells us market focus rests elsewhere at the start of the new month.

Sterling Strength Hampering UK Export Growth

The release of Manufacturing PMI came with a warning attached:

“The appreciation of sterling is holding back the progress of UK exporters. It seems that, despite years of talk about a rebalancing of growth, we are still seeing only limited headway in moving away from consumer driven expansions and towards a greater contribution from exports,” says Rob Dobson, Senior Economist at survey compilers Markit.

The negative take on the strength in the British pound is contrasted to a more upbeat report issued in the previous month, this time from the CBI.

As we noted, the increased value of the UK currency is yet to significantly hit export strength.

The CBI reported a 7 month high in manufacturing activity noting that export orders picked up significantly, to a level not seen for six months.

No doubt, as the pound continues its advance against the euro the issue of currency strength will become increasingly relevant.

Watch out for an Improving Eurozone Economic Performance

Could the euro be about to surprise us with a period of strength?

With the market so heavily pitched against the euro any positive surprises will certainly make itself felt.

“The major surprise and talking point though may be the Eurozone where the weak euro is boosting exports and falling energy costs increasing consumer spending,” notes Carl Hasty at Smart Currency Business.

Longer-Term Risks to the Sterling Euro Rally: UK Elections

“While our view of further EURGBP depreciation remains driven by our expectations for UK economic outperformance relative to other European economies, the current highly uncertain 7 May election outcome increases the risks around our forecasts,” say Barclays.

Analysts believe that while markets appear to be well pricing election-day risks (perhaps too richly), they may be under-pricing the risks that uncertainty may persist well after the election, particularly in the case of a minority, unstable coalition government or even snap elections.

What to Watch This Week

Looking at the nearer-term picture, Barclays forecasted manufacturing PMI (Monday) to increase to 54.0 from 53.0 (consensus: 53.3) in February due to lower oil prices and February services PMI (Wednesday) to pick up to 58.0 from an already-high 57.2 (consensus: 57.5), consistent with upside surprises in flash services PMIs in France and Germany.

February UK construction PMI will also be released on Tuesday and the market is forecasting a mild moderation to 59.0 from 59.1 in January.

Analysts at the British bank do not expect any change in monetary policy at the BoE’s March meeting (Thursday), consistent with the recently released Inflation Report and MPC minutes.

A split vote on the Bank Rate could materialize again as we move into H2 15, but most likely not before.