BMO Capital: British Pound & Dollar to Rise, Euro to Fall in Post-Trump Exchange Rate Landscape

• Pound to Euro exchange rate today: 1.1653 (16-11-16)
• Euro to Pound Sterling exchange rate today: 0.8578
• Pound to Dollar exchange rate today: 1.2477

The outlook for Pound Sterling has improved markedly now that Donald Trump get's to influence the new global order and it is the Euro that could struggle going through 2017 argue analysts at BMO Capital in a new brief to clients.

Sterling has strengthened since Trump's victory partialy due to growing hopes that Britain will be able to eke out an improved trading relationship with the US under a Trump administration.

The US accounts for around 30% of the UK's trade mix and the hope is that a pickup in trade with the country can pick up some of the slack left by an exit from Europe.

It is also being argued that the prospect of improved trading relations with the US will allow the UK a stronger arm when negotiating with Europe over Brexit, and should the UK walk away with a decent deal the Pound should move higher.

"We believe that Trump’s victory has cornered the European parties that have sought to make Brexit as painful as possible for the UK and thereby raised the odds of the UK and EU reaching a favourable Brexit deal that mostly preserves the economic status quo," says BMO Capital's Stephen Gallo in a foreign exchange briefing to clients.

Europe needs good trade relations with the UK regardless because as we note here, German GDP is highly dependent on the UK market.

Studies suggest that 20% of Germany's mighty current account surplus is derived from exports to the UK which could explain why Chancellor Angela Merkel appeared to rowback on the mantra that the freedom of movement of EU citizens was not up for debate if the UK were to seek single-market access.

Analysts at BMO Capital say the next potential bullish driver for the Pound against the Euro is likely to come because of the deteriorating political outlook for the Eurozone.

“Because we expect Trump’s win to bolster anti-establishment parties in Europe, we believe that the odds of the UK achieving a soft-Brexit with favourable terms have increased," says Gallo.

Others agree. 

"For the EUR, we think Trump’s victory is another example of the 'Politics of Rage,' to which the Euro Area is particularly vulnerable. As such, we think EUR political risk premium has increased," say analysts at Barclays in a client briefing in which they communicate expectations for further Euro weakness ahead.

A rise in anti-EU parties on continental Europe could possibly lead to a reformation of the intent of the European project, or a two-tier EU with core members moving towards a closer union and countries not wishing to integrate inhabiting the second lane.

The fact the UK has already been through Brexit before the rest of Europe, and the threat that swathes of Europe could be about to have their own 'Brexit' revolution in 2017, may weigh on the Euro versus the Pound.

This leads to a bearish forecast for EUR/GBP from BMO.

Nevertheless, short-term, Gallo sees a probable move higher on the cards into a 0.8700-25 selling zone from where the pair may start to fall.

US Dollar Forecast to Rise on Trump Factor, Anticipated Tax Amnesty

Euro weakness is expected to be especially pointed versus the Dollar argue BMO Capital citing the US Dollar’s rally to be supported in 2017 by Trump’s policy agenda, in particular, his policies regarding corporate taxation.

Firstly, Trump has said he will reduce corporate taxation from 35% to 15%, and this alone would be expected to encourage companies to keep or transfer more of their profits ‘on-shore’ reducing outflows, and therefore encouraging a stronger Dollar.

"Trump, Republicans and even some Congressional Democrats support corporate tax reform, so this looks like low hanging stimulus fruit in the early part of the new Administration link," say CitiFX in a brief to clients in which they too forecast further Dollar strength.

This is pushing up US equities, nominal yields, real yields and inflation expectations, a pretty good deal if you own US assets and USD.

The next policy to benefit the Greenback is his idea to offer an amnesty on offshore assets repatriated, and a one-off 10% tax rate to apply to any money repatriated to the US during a short-term amnesty period.

Gallo estimates this could lead to a backflow of over 1 trillion in offshore profits, 400bn of which is estimated to be in foreign currency.

Obviously, the exchanging of $400bn back into dollars will have an appreciating impact on the Dollar.

The last repatriation amnesty window (HIA) in 2005 coincided with a rally of about 5% in the Fed’s broad real trade-weighted dollar index.

“However, it is important to note that the 2005 rally occurred in the middle of a seven-year USD downtrend," says BMO's Gallo. "An HIA2 in 2017 would come in the middle of a multi-year USD uptrend so it could potentially have an impact bigger than 5%."

The asymmetrical trajectory forecast by BMO for the Euro and the Dollar leads them to downgrade their expectations for the exchange rate, firstly to 1.04 in 3 months’ time and then 1.01 – which is almost at parity -  in 6 months’ time.