The Pound / Euro Rate Defends Key Support Level

The Pound to Euro exchange rate remains firm having seen traders pick up Sterling at discounted levels in the region of €1.14.

The exchange rate is presently seen at 1.1445 as it consolidates ahead of Thursday's General Election and could well test 1.14 again but for now we would suggest the level should hold.

Whether or not the level breaks and Sterling hurtles lower will depend on politics and the European Central Bank - both in focus at the end of the week - but if expectations are met we should see some lift in Sterling.

The recent recovery - albeit small - is interesting as it repeats the performance seen back in mid-March when the Pound to Euro exchange rate briefly fell below 1.14 but then embarked on a substantial rally that eventually took in 1.20.

Above: Forays below 1.14 have proven to be increasingly temporary. Often the Pound rallies strongly after this level is rejected. Much will however depend on the outcome of Thursday’s General Election.

Analyst Bill McNamara at brokers Charles Stanley says he sees the Pound now looking oversold and would expect a near-term line to be drawn under the immediate 1.14 area.

The Pound comes off its fifth consecutive weekly decline against the single currency, “one consequence of which is that it has retreated to levels last seen in early March, when it bottomed out at 1.1388; that level now represents the next area of possible support, not least because it roughly coincides with the January bottom, at 1.1364,” says McNamara.

On both occasions that this level was tested the Pound rallied higher with 1.20 being reached in mid-April.

Could a similar powerful recovery occur again?

“GBP weakness of almost 2% versus the USD and the EUR over the past week, largely in response to the recent narrowing of polls, is an overreaction and that the election thereby presents a short-term upside risk to GBP,” says Marvin Barth, a foreign exchange strategist with Barclays.

Karen Jones at Commerzbank notes the Euro has been unable to push the Pound through a nearby resistance level and as a result she retains a neutral stance on the exchange rate.

Jones notes GBP/EUR has “not quite managed to clear” the 1.1427 recent low and the marginal new low of 1.1421 has not been confirmed by the daily RSI and she is alert to the idea of a small bounce back.

Indeed, at the start of the new week we are seeing the Pound bouncing nicely which would suggest perhaps this bounce is underway.

However, we would caution against expecting a major rally higher in the exchange rate just yet.

We imagine traders will be on the whole quite averse to taking on more exposure to the currency ahead of the June 8 election lest Jeremy Corbyn pull a Trump-esque victory out of the hat.

“Investors will treat GBP trading with caution ahead of the event,” says Petr Krpata, an analyst with ING Bank N.V based in London. “We see potential for some political risk premia to be priced into GBP ahead of the event. The main risk to GBP is an even smaller Conservative majority or a hung parliament.”

From a broader perspective, Commerzbank’s Jones is looking for the Euro to retain a positive bias while GBP/EUR is stuck below 1.1627.

Much will of course depend on the outcome of the election with most analysts saying that a strong win for the Conservatives should prove bullish for Sterling.

And for now markets appear to be confident May can expand her majority.

A day before the election Bloomberg report that, privately, Labour Party officials and candidates are preparing to lose dozens of seats.

A party aide speaking on condition of anonymity said officials had informally generated a list of more than 30 districts they have no prospect of holding.

Three candidates, all fighting to hold seats, said their experience canvassing for votes bore little relation to the polling, with districts where Labour had majorities in the thousands at risk.

The figures being talked about here tally more or less with the 72 seat majority currently being projected by Electoral Calculus.

Upcoming Polls to Watch

With the agenda being clearly tied to politics, we would suggest those with an interest in the market keep an eye on the next set of polls.

Wednesday:

IPSOS Mori, 11:00 AM
Panelbase, afternoon
Comres, evening
ICM/Guardian, late afternoon, early evening

Anytime:

YouGov

Watch Thursday's ECB Meeting

With focus largely on the impending UK election, it would be a mistake to ignore what is likely to be a pivotal meeting for the Euro at the European Central Bank.

The ECB meets on Thursday to deliver their latest assessments on the Eurozone economy and the give guidance as to where they see policy moving in the future.

Of interest to markets will be whether or not the ECB now believes it is time to consider raising interest rates and squeezing back its gargantuan programme of printing money to buy corporate and government debt.

The Euro has rallied sharply over recent weeks against the Pound, Dollar and other major currencies in anticipation of such a shift in attitude at the ECB.

In fact, the Euro is seen as the best-performing currency amongst the world’s ten largest currencies for 2017.

Inevitably, when expectations grow in such a manner, disappointment becomes a substantial risk.

“We think the EUR is vulnerable into next Thursday’s ECB meeting,” say foreign currency strategists with BNP Paribas. “Bullish EUR momentum remains strong, but we think that the market’s expectations for a hawkish ECB meeting Thursday as likely overdone.”

At the meeting, analysts expect risks to growth to be described as ‘balanced’ but them to reiterate that inflation has not showed the same improvement, particularly following the softer than expected readings over the past few months.

Furthermore, the ECB will be very reluctant to further tighten financial conditions, which have already tightened since their March meeting, thanks to rising bond yields and a stronger Euro.

“Although continued inflows into eurozone equities may continue to support the EUR (for more see here), our equity derivative strategy team flag the very extended period of equity rallies without large pullbacks and suggest buying protection,” say BNP Paribas.

Meanwhile, EUR long positioning remains at one of the most extended levels in the past 5 years according to BNP Paribas FX Positioning Analysis. This suggests the prospect of a big corrective move lower is increasingly likely

Furthermore, analysis from BNP Paribas suggests EURUSD is richly valued with a more appropriate valuation on the exchange rate seen at 1.1048.

Regarding the Euro to Pound Sterling exchange rate (EUR/GBP), analysts at the French bank will be keeping an eye on the UK elections noting GBP short positions have largely been unwound which should allow for big directional moves in the currency to occur once more.

“In the short term, a Labour victory, particularly a coalition, would be most negative for the currency,” say BNP Paribas.

The Election and Other Sectors

The Pound is understandably likely to be the conduit of sentiment in the upcoming vote, but what about other markets?

John Wyn-Evans, Head of Investment Strategy at Investec Wealth & Investment looks at other sectors that could potentially be impacted:

"Large capitalisation equities will continue to follow global trends owing to their heavy overseas earnings exposure, with a weaker pound providing something of a boost.

"Mid and small-cap equities with more domestic exposure would fare less well under a weaker pound, reversing some of the recovery they have made as the pound rallied and the economy surpassed most expectations.

"Gilts also tend to follow global trends, but, as we saw last summer, can benefit from their safe haven status in uncertain times.

"However, we suspect that they would not react so well to “tax and spend” Labour plans, even though Labour offers a “softer” Brexit. Also, with a yield of just over 1%, the conventional UK 10-year gilt continues to offer little return.

"We have a marginal preference for Index-Linked Gilts which offer protection against inflation caused by a weak pound.

"Putting all this together, we find it difficult to make a case for specific evasive action ahead of Thursday, especially as the betting markets still find a decent Conservative majority to be the most probable result. If not, our existing exposure to non-UK assets will provide a decent cushion."