Pound / Euro Decline Tipped to Slow by Scandanvian Lenders

"Expect the strong EUR-sentiment to ease. EUR has rallied more than fundamentals and see risk of verbal intervention from ECB to limit further upside short term"

• Quotes:
• Pound to Euro exchange rate today: 1 GBP = 1.0861 EUR
• Euro to Pound Sterling exchange rate today: 1 EUR = 0.9208 GBP

Pressure on Pound Sterling has eased into the final session of what has been a tough week for the UK currency, relief is coming in part due to caution on the Euro ahead of Friday’s speeches from key central bankers.

Another factor, we believe, for the small advance in Sterling are comments made by UK Foreign Secretary Boris Johnson who has accepted the country will have to pay a bill to exit the EU. Recall the EU wants to make progress on the issue of the financial settlement if talks are to progress.

This is another sign that the UK is getting serious.

At the time of writing the Pound to Euro rate is seen at 1.0855 having gone as low as 1.0826 earlier in the week. This gives us a EUR/GBP at 0.9212 which went as high as 0.9237 mid-week. 

Despite a little relief in the latter half of the session, analysts say the outlook for the UK currency remains bleak.

Uncertainty stemming from an absence of progress in the Brexit negotiations and the ever-present possibility of an exit from the European Union on WTO terms are why the pound could remain the most undervalued currency in the G10 for some time to come.

“Current pricing factors in UK weakness. However, we expect the real effects of Brexit to be severe and the inflation peak to be behind us,” says DNB FX strategist, Magne Østnor.

The analyst warns the Bank of England could remain on hold, keeping the Bank Rate at its record low of 0.25%, for as much as four years.

This, combined with Brexit-related uncertainty and a problematic current account deficit, is likely to weigh further on the pound over the coming years according to Østnor and his team.

However, there is the potential for a pullback in Euro strength in the near-term ahead of a continuation of the currency’s climb.

“Expect the strong EUR-sentiment to ease. EUR has rallied more than fundamentals and see risk of verbal intervention from ECB to limit further upside short term,” says Østnor.

The EUR/GBP exchange rate is forecast to fade back to 0.90 by November, which gives a rise in GBP/EUR to 1.11.

However, further out DNB forecast EUR/GBP to rise to 0.91 in the first-quarter 2018 and 0.92 in the third-quarter 2018.  

This gives us GBP/EUR at 1.10 and 1.09.

The above forecasts actually provide an antidote to the recent doom-and-gloom forecasts provided by some prominent investment banks for Sterling-Euro to fall to parity. As we have noted these kinds of forecasts tend to garner much attention in the popular press.

DNB appear to stand with fellow Nordic investment bank Nordea in suggesting such a fall would be a step too far even if they do hold a bearish outlook for the currency for coming years.

The Pound to Euro exchange rate has fallen by 7.49% for the year to date and is more than 20% lower from the 1.3157 level it traded at in final hours of June 23, 2016.

Sterling's Extended Undervaluation

What is also widely-accepted is Sterling is oversold on a fundamental valuation basis.

We have recently reported the views of various analysts that place the undervaluation in the region of 4%-20%, depending on the model deployed.

SEB Bank say they believe Sterling currently trades at a 22% discount to its long term trade-weighted fair value.

SEB note the Pound is more than 35% undervalued when compared with the most expensive currency in the G10 basket - the New Zealand dollar.

“However, given recent political development and considering the Brexit uncertainty a more substantial recovery seems unlikely, although valuation should slow down further weakness,” says SEB economist Richard Falkenhäll.

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... But The Trend is Still Lower

Sterling’s decline eased slightly on August 24 - August 25.

Much of the bounce in Pound-based currency pairs came on the back of second-quarter GDP and business investment data, which revealed a brighter outlook for capital spending in the second half and highlighted the possibility of an uplift in economic growth toward year end.

It also came against a backdrop of caution ahead of Friday’s speeches by Federal Reserve chair Janet Yellen and European Central Bank boss Mario Draghi, which left both the US dollar and euro subdued.

Nonetheless, and despite the discount carried by the currency, there is near-unanimity in projections that the outlook for Sterling remains bleak going forward.  

Strategists at UniCredit see Brexit negotiations hitting multiple stumbling blocks over the months ahead, ranging from the so-called Brexit Bill to an eventual deal over citizens rights, which could mean it is December time before any form of progress is made.

“The resulting uncertainty will lead the BoE to leave its monetary policy stance unchanged throughout the period of Brexit negotiations... We see further upside for EUR/GBP,” says UniCredit FX strategist Tullia Bucco.

So the takeaway if you put all the above together? More downside, but at a slower pace than we have seen of late with parity looking out of reach.

Johnson's Comments on Brexit Bill Points to More Constructive Position

As ING note - it will take a substantial deterioration in Brexit talks to prompt the Pound / Euro rate down to parity.

It would appear that the UK Government is taking the issue seriously with comments from Foreign Secretary Boris Johnson catching market attention.

Johnson, a pro-Brexit figure in the Government who had earlier dismissed talk of paying a bill, has confirmed the UK will meet its obligations on the matter.

Johnson told BBC Radio 4 that the UK would abide by its financial obligations "as we understand them".

The EU has said it wants to see progress made on the matter of the bill before advancing talks. Recent concessions by the UK make this the more likely.

This is positive for Sterling we believe.