Lloyds: British Pound to Advance Against Euro Near-Term, But Longer-Term Targets are Lower

Pound Sterling ended Friday higher than where it opened against the euro ensuring the under-pressure UK currency recorded a second consecutive day of advances.

However, the Pound to Euro exchange rate still ended the week notably lower (1.1723) than where it started (1.1906), ensuring we have seen three consecutive weeks of declines; of the past six weeks five of them have ended lower than where they started.

This tells us momentum greatly favours the Euro at this juncture and on momentum studies alone we would have to advocate for further losses.

The British Pound advanced against the Euro in strong fashion ahead of the weekend, in tandem with a broad-based pick-up in investor sentiment.

As usual, we look to the German DAX for indications of said sentiment as we believe this market is more applicable to moves in GBP/EUR. In short, when the DAX is rallying, so is the pound to euro exchange rate.

The Pound is a 'risk on' asset owing to its Brexit-inspired riskiness, therefore it will likely benefit when markets are rallying, and suffer when markets are selling off.

Nevertheless, this does not alter the outlook for the pair and analysts continue to advocate for further advances by the EUR against the GBP.

Analysts at Lloyds Bank Commercial believe that a break of 1.28 in GBPUSD and 0.8650/0.8700 in the Euro to Pound Sterling exchange rate (EUR/GBP) would trigger further GBP weakness.

This equates to a break below 1.1561/1.15 in GBP/EUR terms.

However, some room is given for a short Pound Sterling recovery.

“For now though, intra-day studies are still unwinding from over bought suggesting a broader correction is still possible – initially towards 0.8450 and subsequently 0.8390/50,” says Robin Wilkin at Lloyds.

Again, for those looking at a GBP into EUR conversion the three numbers equate to a near-term corrective bounce to 1.1834, 1.19 and 1.1976 respectively.

It is believe that should these areas be breached, it may provide the impetus for a deeper test of  support in the 0.8150/0.8050, which would add conviction to the view that a broader correction is underway.

(A further recovery in GBP/EUR to 1.2270 and 1.2422).

Long term, Lloyds believe this move to the topside is the last within the correction from the 0.70/0.69 support region.

Above 0.8700, sees next resistance in the 0.9000-0.9200 region.

(0.70 = 1.4286, 0.69 = 1.45, 0.87 = 1.15, 0.90 = 1.10,  0.92 = 1.0869).

Latest Pound/Euro Exchange Rates

	Live: 1.1391▼ -0.13% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1004 - 1.1049
**Independent Specialist	1.1232 - 1.1277 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

European Bank Provide a Question Mark

Political uncertainties due to Brexit and European bank's recapitalisation needs are likely put the EUR under moderate selling pressure against the US dollar, but not necessarily against the Pound.

The niggling concern over European banks has been a growing theme for market watchers this week, and don't be surprised if it grows in importance over coming weeks.

As we have said, the Pound benefits when markets are in a positive frame of mind, and it suffers when they are not.

Therefore, troubles in the European banking sector are likely to be a negative for the £.

Removing the uncertainties related to some of the Eurozone's banks such as the broader Italian banking sector, and sector giant Deutsche Bank, could see the EUR rebounding with commercial EUR buying providing support.

Europe and its weak European banking sector may be affected, "but there could still be a policy response preventing weak European balance sheets becoming a global issue at this stage," says a note from Morgan Stanley.

Of course, Italian banks' EUR360bln of nonperforming loans are large relative to the size of the Italian economy and the size of bank balance sheets, but potentially not big enough to cause systematic risks on a global scale(see our bank analyst's write-up).

"However, there is a political dimension to this problem which has the potential to impact markets globally, coming into force if PM Renzi loses his Senate referendum in October, not only creating a political vacuum should PM Renzi resign, but also increasing the probability that Italy installs an EMU-critical government aiming to take Italy out of the currency union," say Morgan Stanley's Hans Redeker.

Italian retail sales – a reflection of Italy’s tense political climate– have dropped to a 31-month low.

Bank Rescue may Trigger a EUR Rally

"We see EUR trading within a binary framework," says Redeker. "Should investors put the existence of EMU into question – which could happen should Italy bring in a euro skeptic government– then we believe that EUR would sell off hard."

Over recent days when Italian bank debt and its share price development dominated news, the break-up risk premium increased,causing EURUSD to trade moderately lower.

A precautionary bank capital injection would buy EMU sometime. Consequently, the EMU break-up risk premium would decline and hence EUR would rally.

For EUR to weaken, long-term capital outflows must exceed commercial EUR buying needs generated by EMU's ever-rising current account surplus argues Redeker.

Weak balance sheets combined with low nominal bond yields and falling global inflation expectations take currencies within the current account surplus environment higher.

"We reiterate our call for EUR to trade higher from here unless populism changes the political landscape, putting EMU's existence into doubt," says Redeker.

EURGBP has further upside potential from here believe Morgan Stanley, "should expectations of the UK aiming for an early GBP undershoot and EMU officials trying to support Italy’s PM Renzi as much as possible come to fruition."

Euro to Dollar Exchange Rate: Tight Consolidation

For a second consecutive session, EUR consolidated in a tight range, potentially building tension that may exacerbate the next breakout.

At this stage the Lloyds technical team remain biased for a move lower.

“However, intra-day price action is beginning to cause some concern – with EUR managing to hold a bid tone through yesterday’s session,” says Wilkin.

A move below 1.1055/35 should trigger further weakness, towards the key interim support region at 1.0940/10, with a break there leading to a re-test of key technical support in the 1.0825/1.0750 area.

Lloyds expect EUR strength to be limited to 1.1170/1.1200. A rally above 1.1225/35 may reverse the pressure and threaten the 1.1420 highs.

“Longer term we are becoming wary that 1.0450-1.17 range is developing as a “flag” consolidation ahead of a test of key longterm support in the 1.00-0.99 region. We are monitoring this for greater clarity and confidence in this view,” says Wilkin.

UK Trade Balance Confirms UK Still Struggling to Export

The UK economy remains one that is heavily reliant on imports, as confirmed by the latest trade data from the ONS.

This suggests that the Pound will likely struggle owing to the country’s demand for foreign exchange.

The Trade Balance for May read at -9.88BN Pounds, Better than the forecast -10.65BN.

Nevertheless, the deficit still widened by £0.3bn on the month.

However, looking ahead, the 10% or so fall in trade-weighted sterling since the referendum should help to boost exports in time.

Although any improvement is likely to be slow against a background of fairly sluggish global growth and uncertainty about future trade relationships between the UK and other countries.