GBP/EUR Exchange Rate: Lloyds Update End-2017 Forecast

Lloyds Bank say the Pound to Euro exchange rate is unlikely to advance further than current levels dealing a blow to those hoping for the recent recover to take the rate into the early 1.20s.

Researchers at Lloyds Bank have told their commercial clients that their analysis suggests the Sterling is close to what they would consider a fair valuation against the Euro at the present time.

This will come as a disappointment to those watching the market in the hope Sterling was on the cusp of a notable period of recovery against its European counterpart.

Hopes rose as the Pound jumped against the Euro and recorded a multi-month high 1.2028 on April 18 after Theresa May announced a general election would be held on June 8.

It has since faded back to 1.1855 but does trade with a positive tone.

The move higher proved brief and left those without pre-set buying orders high-and-dry as they missed the chance to transact at the magical 1.20 level.

However, the levels have proven to be unsustainable and the Pound to Euro exchange rate now sits at 1.1728.

That we have fallen right back into familiar territory is testament to the view that 2017 might not offer those hoping for a stronger exchange rate what they desire.

However, uncertainty does remain high with analysts forecasting the Pound to Euro exchange rate to end the year anywhere between 1.00 and 1.30.

But, it’s a Political Exchange Rate and Therefore Anything can Happen

For Lloyds, politics remain front and centre when it comes to gauging the outlook for GBP/EUR.

However, these risks are now seen subsiding with Emmanuel Macron seen as shoo-in as the next President of France and the UK heading for a general election that should provide longer-term political stability.

Sterling showed some upside against the Euro, with the move apparently being related to polling showing that the Conservatives are likely to increase their majority and current bookmaker odds are also indicative of this.

“This could potentially strengthen Theresa May’s position in Brexit negotiations domestically, enabling her to take a less hard-line stance on EU exit. In addition, the market appears to hold a belief that the possibility of a transitional agreement at the end of the two-year negotiation period has also increased,” says Gajan Mahadevan, a Quantitative Strategist with Lloyds Bank.

Ultimately though it is all about upcoming Brexit negotiations for the Pound and this is where uncertainty lies.

“Negotiations with Europe relating to the UK’s exit from the bloc are another key factor in determining how GBP/EUR performs in the medium term,” says Mahadevan.

The Bank of England vs the European Central Bank

For the Euro, now that political risks have subsided there is the prospect of markets starting to focus on central bank policy.

The important question as we have noted on numerous occasions is when will the ECB withdraw its quantitative easing programme, and when will they raise interest rates?

Arguably as important, is when will they hint at such a move? This would be the trigger to a stronger Euro should the Bank of England not offer similar hints towards such action here in the UK.

The central bank which kick-starts the process will send government bond yields higher and this will in turn push demand for their respective currencies.

In recent months, market expectations have suggested that monetary policy was likely to
be side-lined as a driver of GBP/EUR.

Implied market pricing still indicates that both the BoE and ECB are likely to leave their respective headline policy rates unchanged for the rest of 2017.

“However, following their March meetings, the market has been alerted to the prospect of both central banks shifting their stances,” says Mahadevan.

While the BoE left its Base Rate unchanged at 0.25%, a surprise was sprung by the
MPC’s 8-1 vote.

Kristin Forbes – among the most ‘hawkish’ on the committee and who had previously opposed some of the emergency easing in the aftermath of the EU referendum – plumped for an immediate hike in interest rates.

“This caught the market off guard. However a wider shift in view across the MPC seems unlikely at this stage,” says Mahadevan citing recent economic underperformance in the UK.

The analyst cites as evidence the latest UK retail sales release which showed a slum of 1.8%, while the quarterly pace of expansion for Q1 recorded a decline of 1.5% (sharpest quarterly fall since 2010).

The disappointing consumer activity, in an environment of rising prices and stagnate wages, is a key risk highlighted by the BoE.

“It therefore seems unlikely that the committee as a whole will move towards favouring tightening against this backdrop. We do not expect a rate rise from the BoE over the next two years.

In a similar vein, last month’s ECB meeting saw policy rates unchanged.

“Yet, excitement was sparked by suggestions that the Governing Council had discussed the potential to raise the deposit rate before the conclusion of its quantitative easing programme,” says Mahadevan.

The Euro was however put back on a leash after President Draghi and Chief Economist Praet pushed back against these expectations suggesting it is still too early to jump headlong into the Euro.

The market implied probability of a deposit rate hike before the end of the year is now at 27% (having been as high as 50%).

The ECB opted to leave policy settings unchanged at their April policy meeting but the accompanying statement and press conference corresponded with a fall in the Euro against the likes of Sterling and Dollar.

The Bank announced the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively.

In the press appearance following the release ECB President Mario Draghi gave Euro-bulls nothing to bite on and towards the latter part of the conference the Euro came under noted selling pressure as Draghi hammered home the point that there were no plans to withdraw stimulus in the near-future.

"Net asset purchases of 60 bln p/m intended to run until the end of December 2017, or beyond, if necessary," said Draghi.

Draghi notes the Eurozone economic recovery is becoming increasingly solid and downside risks have further diminished.

But, inflation pressures remain subdued and are yet to show a convincing upward trend, particularly core inflation.

Forecasts Show a Tight Range for 2017

No change to the Bank's agenda will be forthcoming until inflation goes higher - and inflation is the bottom line for the the ECB which has no mandate to target economic growth.

"The Euro drops as ECB's Draghi says there is no sufficient evidence to alter inflation outlook, no evidence of self-sustaining inflation mov," says Holger Zschaepitz, Senior Editor of the Financial Desk at Welt.

Volatility in the headline inflation rate means we need to look through volatility argues Draghi referring to that patch of strong inflation we saw earlier in 2017.

In short, further support from the ECB is required to keep inflation sustained, and the Euro doesn't like this.

While Lloyds Bank do see the potential for the ECB to raise policy rates before the end of its quantitative easing programme, they do not envisage this occurring until mid-2018.

“The next milestone to watch for is a change in the central bank’s forward guidance. We expect this to come at the next policy meeting in June, where the ECB may remove reference to the possibility of ‘lower’ rates,” says Mahadevan.

So its a case of watch-and-see on all accounts. Big moves do lie ahead and those with an interest in the market should keep a handle on all the above factors.

For now though, it’s a waiting game.

Lloyds Bank forecast GBP/EUR to trade around 1.18 at the end of the year.