GBP/EUR Week Ahead Forecast: Valuation Curbs Losses as Data Eyed

  • GBP/EUR support at 1.1523 on charts short-term
  • Rough 1.1581 to 1.1622 range confines this week
  • But mid-term ‘fair value’ between 1.1519 & 1.1965
  • UK GDP in focus as European calendar falls quiet

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The Pound to Euro exchange rate currently sits near the bottom of its medium-term equilibrium range, suggesting only limited scope for further losses in the short-term, though it could be most likely to trade in a narrow band covering the distance between roughly 1.1581 and 1.1622 this week if the author’s model is anything to go by. 

Pound Sterling entered the new week near one-month lows against the Euro after coming under pressure from most currencies last Thursday when the Bank of England (BoE) raised Bank Rate to 5.25% but waxed double on the outlook for borrowing costs and the economy going forward.

“If the Bank of England pauses now or hikes once more (as we expect), front-end rates will need to adjust lower, likely dragging GBP with it,” warns Parisha Saimbi, an FX strategist at BNP Paribas. 

“If more aggressive tightening needs to be delivered, markets may anticipate a harder landing, which may limit GBP’s ability to strengthen as hikes are delivered, and could cause it to eventually weaken as sharper rate cuts (later on) become priced,” she adds, in a research note last week.

The BoE’s new forecasts were modelled on the assumption that Bank Rate would rise further to 5.75% this year and its highest since the late 1990s before being held there for as many as three years but the bank and Governor also both made clear that additional increases are by no means assured. 

Above: Pound to Euro rate shown at daily intervals with selected moving averages and Fibonacci retracements of 2023 rally indicating possible areas of technical support.

Much about the outlook for interest rates likely depends on the trajectory of inflation in the months ahead and on how the economy fares in relation to BoE forecasts, which is why Friday’s release of economic growth numbers for June and the second quarter are the highlights of the week for the Pound to Euro rate. 

“Our economics team's view is that another 25bp increase to 5.50% in September is likely, but that may well be the end of the cycle as inflationary pressures abate. This leaves room for a rebound in EUR/GBP to the 0.87-0.88 [GBP/EUR: 1.1360 to 1.1494] area by year-end,” says Francesco Pesole, an FX strategist at ING. 

Friday’s GDP data is the highlight of an otherwise quiet week ahead in the UK and European economic calendars but would potentially impact market expectations for Bank Rate and the Pound if disappointing numbers undermine the BoE’s view that the economy likely grew 0.2% in underlying terms during the opening half of the year. 

“We expect June GDP to expand 0.3% m/m. We forecast Q2 GDP to print at 0.1% q/q, driven by a normalisation in government consumption following fewer industrial action disruptions than in Q1, while private consumption remains sluggish,” says Abbas Khan, an economist at Barclays. 

The economist consensus is for the UK economy to have grown 0.2% in June to leave GDP unchanged with zero percent growth for the second quarter, which would suggest the economy underperformed Bank of England expectations over the recent month. 

Above: Real and nominal equilibrium or ‘fair value’ estimates for selected pairs. Source: Pound Sterling Live. Click for more detailed inspection. 

“We think EURGBP can rally back to the middle of its long-term range, such as back into the .8800s [GBP/EUR: Below 1.1360]. If EURGBP were to fall below our line at .8500 [GBP/EUR: Above 1.1764], then downside potential will increase,” says Paul Ciana, chief technical strategist at BofA Global Research. 

Weakness in Friday’s growth number could lead analysts, economists and financial markets to look again at their assumptions about the outlook for Bank Rate and while having the effect of keeping pressure on the Pound to Euro rate, though technical support around 1.1523 on the charts might also be likely to frustrate any further losses.

Another potentially supportive factor for the Pound this week and thereafter is its current position near the lower end of an estimated medium-term equilibrium or ‘fair value’ range, which currently spans the gap between 1.1519 and 1.1965 if the author’s valuation model is anything to go by. 

The model discounts selected exchange rates with past and present inflation rates as well as with inflation and interest rate differentials in order to derive multiple assets of real and nominal equilibrium values, which can be useful as a guide for medium-term expectations of exchange rates (See above).

The author’s short-term forecast model, meanwhile, suggests the Pound to Euro rate is likely to spend much of its time confined in a narrow 1.1581 to 1.1622 range this week.

Above: Quantitative model estimates of possible ranges for week ahead. Source: Pound Sterling Live.