Pound Euro Ready to Pop: Interest Rate Rise Forecast in November

Exchange rate forecasts from UniCredit suggest currency markets may be under-pricing the value of the pound to euro exchange rate.

In currency markets once thing matters above all - moves in central bank interest rates, the general rule of thumb is when rates rise so does the domestic currency.

Of course interest rate moves are dependent on the underlying economy which makes calling central bank thinking incredibly hard as data beats expectations one month only to underwhelm the next.

With regards to the British pound markets pricing in a GBP-positive interest rate rise around the second quarter of 2016.

All said, economic data and interest rate expectations leaves the British pound to euro exchange rate conversion trading at 1.40 at the time of writing. This is the level markets see as appropriate when a Q2 interest rate rise is factored in.

However, we hear from one analyst that this timing is too pessimistic and a rate rise will happen sooner.

If this view is right it will hold important implications for the pound to euro exchange rate - the currency may be priced too low.

Those looking to make an international payment must remember that all currency quotes here refer to the spot market rate - the rate your bank offers will be less as a spread is charged. If you want to get as close to the spot market rate as possible use an independent provider who specialises in such matters, you could end up with up to 5% more FX by doing so.

Calling a November Interest Rate Rise

With headline inflation so low, the BoE has signalled it is in no rush to raise interest rates.

Financial markets believe this and expect the first 25bp hike in July 2016, with only very gradual subsequent increases thereafter.

However, as headline inflation moves higher, the conditions are in place for the BoE to hike earlier than markets are currently pricing.

“The MPC expects spare capacity to be fully absorbed within a year and for wage growth to pick up to its long-run average next year. If the Fed hikes this September, as we forecast, then it will open the door for the BoE,” says Daniel Vernazza, analyst at UniCredit Bank in London.

UniCredit expect the first BoE hike in November of this year, around eight months earlier than financial markets are fully pricing, followed by subsequent hikes of 25bp to 1.75% by end-2016.

The recent news on the UK economy suggests the recovery was somewhat stronger than previously estimated, but growth is now levelling off to a rate close to, or slightly above, its potential suggests Vernazza.

Substantial upward revisions to construction output over the last year mean that GDP growth is set to be revised up to 2.9-3.0% in 2014 and that the surprisingly weak 1Q15 is set to be revised up to 0.4% qoq, when the next vintage of the data is published on 30 June.

UniCredit expect growth to pick up to 0.6% qoq in 2Q15, but the underlying trend is one of a modest slowdown.

If a November rate hike is delivered we see a great deal of re-pricing ahead for the currency markets with the pound sterling having to make significant advances.

However, UniCredit who are making the November call actually see the pound v euro rate lower than it is at present.

We are quoting the spot market rate at 1.40 at the time of writing and UniCredit forecast GBP-EUR at 1.38 at year end.

A rise to 1.40 is forecast for June 2016, marking the high water mark for the pair in the opinion of UniCredit.