"Turning Constructive on the Euro" Against the Pound and Dollar: Standard Chartered

Above: Standard Chartered's global headquarters in Moorgate, London. Picture Credit: Gary Howes, Pound Sterling Live.

• Quotes (3-5-17):
• British Pound to Euro exchange rate: 1.1831
• Euro to Pound Sterling exchange rate: 0.8451
• Euro to Dollar exchange rate: 1.0914

Foreign exchange analysts at one of the world’s largest financial services providers have announced they are now, “turning constructive on the Euro.”

Standard Chartered bank’s Wealth Management Group have told clients that the Euro is to experience a period of outperformance in the medium-term i.e. broadly over the remainder of 2017.

“We expect the EUR to extend gains over the medium term,” says a note to clients released by the London-based bank in a note dated April 28.

There are two main drivers of this constructive view on the Euro:

First, the European Central Bank (ECB) is likely to scale back its stimulus later this year as the Euro area economic recovery extends.

“We believe the scale-back in ECB stimulus is likely to lead to higher Bund yields, which (net of inflation) is likely to narrow yield differentials in favour of the EUR. The main risk here is if the Euro area recovery fails to sustain,” say Standard Chartered.

Bund yields are the coupon payments made on Germany's state debt - one of the most sought-after investment destinations in global finance and a key pillar of Euro strength.

Second, analysts believe, political risks related to the rise of eurosceptic parties are likely to diminish going into the second half of the year.

“We believe the possibility of eurosceptic parties coming to power in France has diminished significantly following recent first-round French election results,” say Standard Chartered.

The note comes as centrist candidate Emmanuel Macron maintains a healthy lead over his rival Marine Le Pen.

Markets now see little lead to hedge against the event of a Le Pen win and the Euro has shed much of the risk premium that has been weighing since the start of 2017.

Standard Chartered are not the only investment bank to have turned positive on the single currency of late.

We have reported recently that Nomura are increasingly bullish on the outlook saying the fundamental picture underpinning the Euro has improved notably of late.

Strategists at Credit Suisse have meanwhile entered a trade that seeks to take advantage of Euro strength against Pound Sterling over the course of the coming three months.

This echoes a similar trade seeking to benefit from Euro strength entered by JP Morgan.

British Pound Outlook More Supportive

Turning to the Pound side of the Pound to Euro exchange rate equation, Standard Chartered suggest that the outlook is improving.

Recall that in mid-April we reported analysts at the bank expected Pound Sterling to outperform the Euro for a month.

So far that call appears to be accurate.

“We believe that most of the risks to the GBP have been priced in,” say Standard Chartered. “However, we prefer to wait to see further evidence of a stronger recovery in the UK economy before major GBP gains.”

The recent strengthening in Sterling is seen aiding the UK consumer as it is expected to have reduced inflationary pressures.

Recall that much of the UK’s recent economic slowdown rests with a more cautious consumer that has put back expenditure decisions owing to rising prices.

These stem - to a significant degree - from the fall in value of Sterling which pushed up the cost of imports.

All said, Standard Chartered are neutral on the Pound’s outlook having previously been negative.

When contrasted against their bullish view on the Euro we get the view that pressures in GBP/EUR will be tilted to the downside - or at best - upside pressures will remain capped.

US Dollar has Peaked

Concerning the Dollar, “we believe the USD has likely peaked,” argue Standard Chartered.

This view is an increasingly popular one and we have been reporting this stance to be increasingly prevalent with HSBC recently striking a similar tone.

“While the Fed is likely to continue hiking interest rates, we believe that policy divergence is approaching extremes,” say Standard Chartered.

Policy divergence refers to the advantage bestowed on a currency by its central bank. In this case the Dollar has been supported by the US Federal Reserve which has been pursuing a policy of raising interest rates while other banks stood still. This advantage will be lost were other central banks to start an interest rate raising cycle.

“If anything, the pivot towards reflation has been most apparent in Europe than in the US in the past two months. While the ECB continues to focus on benign core inflation at the moment, we question how long it could continue,” say Standard Chartered.

Against this backdrop, analysts doubt the USD will rise strongly from here.

“Indeed, we believe that the EUR has bottomed and is set to rally further in the coming weeks and months against the USD,” say Standard Chartered.

However, seasonality is quite important for the Dollar at this time of year with past performance showing it tends to rise in May, so be wary of a Dollar comeback.

Sterling Retains Upside Momentum

Meanwhile, the British Pound retains a positive bias.

Sterling rose toward seven-month highs against the US Dollar after stronger-than-expected U.K. data eased worry over growth moderating in the months ahead.

"Manufacturing growth unexpectedly accelerated and to the strongest in 3 years in March, showing how the weak Pound remains a boon for the factory sector, making U.K. goods more affordable on the global stage. The data offered hope that Thursday’s more influential services PMI could also surprise to the upside which would keep in the conversation the notion of an early U.K. interest rate hike from rock bottom lows," says Manimbo.

So all eyes turn to Thursdays Services PMI release for fresh guidance on the economic front.