"Pound Sterling Spike Demands Respect" says Soc Gen as GBP/EUR Exchange Rate Eyes 1.1930

GBP is looking strong heading into the month-end having recorded a move higher to 1.1883 having been as low as 1.1841 earlier in the session. 

Pound Sterling appears to be in a hurry to recapture the ground it lost to the Euro in the wake of Emmanuel Macron’s victory in the first round of the French Presidential election.

The Pound to Euro exchange rate rose to 1.1865 ahead of the weekend and must retake levels in the region of 1.1930 to cancel the Macron inspired losses.

We have however seen the Euro put a dent in the Pound's ambitions following the release of some stronger-than-forecast Eurozone inflation data which has ensured that the shared currency is actually the day's best performer.

Nevertheless, markets are also largely technically driven at present and near-term gains in Sterling cannot be ruled out on this basis.

“Regardless of the performance of the Dollar and the Euro, Sterling shows solid resilience,” notes analyst Piet Lammens with KBC Markets in Brussels who take a bullish view of Sterling’s near-term prospects.

The move higher comes despite some underwhelming GDP data which has confirmed the UK economy to have slowed in the first quarter of 2017. Indeed, the move higher looks technical in nature.

“Sterling bears are facing a short squeeze today as the Pound ramped up,” says Neil Wilson at ETX Capital. “With the market so heavily short some sellers are giving up the ghost.”

“The Pound is battering at the doors of all its major currency partners. If next week’s slew of UK data is as positive as other recent economic news, Sterling could well start May by flexing its muscles again,” says David Johnson of Halo Financial.

Kit Juckes, an analyst with KBC Markets in London is wary of trying to stand in the way of the Pound at this juncture:

“There is no significant new news in the UK but Sterling bears are still being run over by a rogue steamroller.

As can be seen above, the Euro to Pound exchange rate is below the 10-year real yields - the yield paid out to holders of German government bonds. As can be seen, this is something the Euro tends to follow closely.

However, of late the Pound has pulled the Euro lower, and this is proving frustrating for seasoned analysts such as Juckes.

“I thought the spike in yields would have seen the FX cross follow through. It hasn’t happened yet. The Sterling spike demands respect, even if it infuriates me!” says Juckes.

The jaws must close, therefore ultimately the Euro must rise and take the EUR/GBP exchange rate higher with it to meet the bond yields, or yields must come down.

Right now it looks like Sterling will win this out, particularly if we note Eurozone bond yields have fallen in the wake of the most recent European Central Bank policy meeting in which we heard ECB President Mario Draghi say he is not yet ready to even consider raising interest rates or withrawing the Bank's massive bond-buying programme.

Remember, the ECB is buying bonds and when demand for bonds rises the yield paid by those bonds falls.

Thus, the ECB is able to put a cap on bond yield rises, and by extension the Euro.

Euro Strength… in June?

So for the Euro, it is all about when the ECB drops that hint it is looking to cut back from pumping money into the economy.

"Overall, the ECB used today’s meeting mainly to fine tune its rhetoric in preparation for the 8 June rendez-vous, when we expect important semantic changes. If, as it now seems very likely, the French will elect a mainstream president, at its next meeting the ECB will probably scale back some of its prudence and the new staff projections will finally show growth risks becoming broadly balanced," says Marco Valli
Chief Eurozone Economist at UniCredit Research.

In turn, Valli believes this should convince the ECB to drop some or all the easing-bias references that currently appear in the forward guidance for interest rates and asset purchases.

"Such a change in rhetoric would then pave to the way for the September meeting, when we expect the ECB to announce a further tapering of asset purchases over the course of 2018," says Valli.

So the European summer might just belong to the Euro.