Pound / Euro Finds Buyers at Key Support but any Strength Likely to be Short-Lived
The Pound to Euro exchange rate is seen finding support in the mid-week trading session having fallen 1.69% month-to-date.
The exchange rate is quoted at 1.1365 at the time of writing, having been as low as 1.1302 earlier in the session were it not for a speech from Bank of England Chief Economist Andy Haldane that spurred the Pound higher.
Haldane said in a speech that he expects to vote for an interest rate rise soon; comments that saw the Pound recover from multi-week lows against both the Euro and Dollar.
The comments are significant in that Haldane has been widely held as one of the more conservative members of the BoE when it comes to interest rate rises.
The speech comes just a day after the Pound fell in response to the Bank of England Governor Mark Carney saying he felt no interest rate rise was needed in the near future.
"I think that the balance of risks associated with tightening 'too early', on the one hand, and 'too late', on the other, has swung materially towards the latter in the past six to nine months," says Haldane.
Markets are clearly alert to the fact that interest rates might go higher in coming months - a move that is positive for Sterling as it would likely attract international investor capital to the UK which bids up the Pound in the process.
"A day after Mark Carney soothed nerves by declaring his unwillingness to raise rates, chief economist Andy Haldane chucked a spanner into the works by announcing that he thought the time was nearly upon us. Mr Haldane is one of the internal members of the MPC, and so his conversion from dove to hawk sent the pound flying higher," says Chris Beauchamp at IG.
Buying Interest
But it is not just Haldane propping up the Pound; the currency continues to find support from buyers looking to pick up the currency at bargain prices. A number of analysts now see the Pound as more undervalued versus the Euro than it should be.
It is unlikely that we shall see an extended decline - the post-meeting gains have now been retraced, and there is little else left to discount.
Losses for the Pound are likely to be limited unless a Hard Brexit starts to emerge, according to analysis from Credit Agricole’s Valentin Marinov.
“Our short-term valuation analysis suggests that GBP looks expensive vs USD and Scandis, and cheap relative to EUR, CHF and JPY. At the same time, our long-term valuation model still suggests that the best hedge against a potential hard or disorderly Brexit may be long EUR/GBP,” said Marinov.
One major risk for the Pound is the priority in negotiations that has been given to the controversial issue of Britain’s divorce fee.
Clearly, there is potential for talks to breakdown at an early point if the two sides cannot reach a middle ground specifically on this contentious issue.
Nevertheless, in the absence of the threat of a hard Brexit yet, the Pound could be in a position now to recoup losses versus the Euro, which would see GBP/EUR appreciate.
Technical Outlook Also Suggests Short-Term Relief
Studies show the GBP/EUR pair has just bounced from underpinning support which corresponds with the view that the Pound is so undervalued that only a crisis like Hard Brexit can push it lower.
Broker Charles Stanley’s market technician Bill McNamara notes a level at 1.1300 which supported GBP/EUR’s recent rotation higher.
“It is worth noting that it (Sterling) rebounded off the lows last week relative to the euro, implying that there might now be some support at around 1.13. However, that price action is still somewhat inconclusive and the outlook remains unclear. Resistance is now at around 1.1460,” says McNamara.
Indeed, 1.1300 is a historic level which also supported the pair in the last – and corresponds with EUR/GBP’s 0.89 at the top of its current range highs.
Bearish Forecast Longer-Term
While short-term trade could see some relief for Sterling, the longer-term remains largely negative.
Analysts at Associated Foreign Exchange warn the broader cyclical outlook for GBP/EUR is negative - largely thanks to what's happening with GBP/USD with EUR/USD.
AFEX say whilst they see EUR/USD as having put in a longer-term bottom, they think there is a risk GBP/USD has not yet done so and could go lower.
This means the Euro is likely to be stronger than the Pound and GBP/EUR will fall.
“With both component currencies of this cross pair at different points in their broad cycles (EUR/USD prices look to have bottomed whereas GBP/USD values have not) downside pressure is likely to remain a feature over the next few weeks/months. For now at least some support is apparent toward 1.1250 and while unbroken an intermediate range effectively persists. However rebounds are considered broadly corrective and strong resistance awaits at 1.1550 then 1.1700 areas. Looking ahead if 1.1245/55 support gives way an extension to 1.1100 and 1.0950 is readable next,” say AFEX in a briefing to clients.
Turbulence for the Euro?
It is also worth noting that the Euro side of the GBP/EUR equation could face some difficulty.
Sentiment appears to be turning negative for the Euro after the recent strong run off the back of Macron’s unifying influence.
One illustration in the change in sentiment is Westpac Bank’s recent EUR/USD sell recommendation which would also certainly be felt in EUR/GBP.
The pair has gone from being a neon-lit “Buy” with targets as high as 1.19-1.20, to a sell, according to the bank, who recommend short selling the pair at 1.1200 for a target at 1.0950.
Westpac base their bearish Euro view on the following key factors:
1. Eurozone yield spreads are narrowing and from being more supportive a week ago are now less so.
2. The Macron effect and easing of political risk has now been fully priced in by markets so there is no more upside potential from them.
3. The Slip in ZEW sentiment could start to weigh, whilst a thin economic data calendar will provide no upside surprises into the end of the month.
A recent report from ABN AMRO Bank’s Nick Kounis emphasising the risks to Eurozone inflation which Kounis sees undershooting official forecasts may also reflect a shift in sentiment regarding the single currency.
In the report the analyst argues that Europe’s still-high levels of unemployment make it impossible for inflation to rise to the European Central Bank’s 2.0% target.
Unemployment is still above NAIRU which according to economic theory is the level below which unemployment must fall for inflation to start rising.
Kounis points out that inflation has only ever risen once when unemployment was above NAIRU in the history of the Eurozone.
“We continue to expect core inflation to undershoot what is expected in the ECB’s Staff Macroeconomic projections,” says Kounis.
“Indeed, we are actually somewhat downgrading our view of core inflation from the already weak profile we had earlier,” added the analyst.
If the ECB itself downgrades its inflation outlook or officials hint that it might, this will have a very depressing effect on the Euro, which could see GBP recover and GBP/EUR rise.
