Latest: Pound-to-Euro Rate Forecasts Upgraded at S.E.B

Improved investor sentiment regarding the Brexit process and economy allows another global financial services provider to upgrade their forecasts for the British Pound against the Euro. Here are the new targets and the key issues to watch going forward.

The prospects for Pound Sterling have improved notably over recent weeks, according to new analysis from Skandinaviska Enskilda Banken (SEB), and this has prompted them to revise up their forecast for Sterling.

The shift comes following the September Bank of England policy meeting where members of the Monetary Policy Committee surprised markets by indicating interest rates while have to rise in the near-future.

Politically, Theresa May's Florence speech represents progress on Brexit having proposed a two-year transitional EEA-style relationship with the EU after the official 2019 end date, thus trying to avert a Brexit 'cliff-edge'.

The two events have helped the Pound recover against the Euro with the exchange rate peaking just above 1.14, having gone just below 1.08 in August.

Despite the rally, Sterling remains massively devalued as a result of downwards pressure from the political risk premium demanded by investors owing to Brexit uncertainty.

Take the political lid off, however, and Sterling could rally strongly.

"Any sign of progress in Brexit negotiations would probably reduce the risk premium and strengthen the GBP. We have revised our forecasts in EUR/GBP lower," says SEB's, FX Strategist, Richard Falkenhall.

Brexit: Improved Sentiment, but Upcoming Events to Keep Sterling Capped

May's Florence speech was a game changer for Sterling as it not only proposed a way of avoiding a catastrophic rupture but also suggested flexibility in relation to meeting the UK's commitments to the exit bill.

Markets will be watching the outcome of the fourth round of negotiations which end on Thursday, September 28 for signs of further progress which suggest the EU might be ready to move on to discussing future trading relationships.

An EU summit on October 19-20 will see leaders decide whether negotiations with the UK have made sufficient progress to warrant moving onto 'phase 2', which is how the post-Brexit relationship will look.

News from the latest round of negotiations before the October summit which started this Monday suggest still not enough progress has been made, but the chief EU negotiator Barnier is hopeful May's words in Florence will translate into action around the negotiating table.

"We are six months into the process," said Barnier who gave a cautious welcome to the UK's more progressive stance signalled by May. "We are getting closer to the UK's withdrawal. I think this moment should be a moment of clarity."

Barnier's cautious welcome was echoed by President of the European Council Donald Tusk who met Theresa May for further private talks on Brexit in London.

Emerging from Downing Street after the talks, Tusk said: "I feel cautiously optimistic about the constructive and more realistic tone in the prime minister's speech in Florence and of our discussion today."

However, he said that not enough progress had been made yet to move onto the next phase of talks about the UK's future cautioning that he thought Brexit is not a "good thing" and, "only about damage control."

Bloomberg meanwhile reports that European Union leaders are considering going some way to meet one of the U.K.’s demands. They are discussing bringing forward talks about the transition period that would follow Brexit, according to three people familiar with the situation who declined to be named.

Key Event

From the perspective of the Pound's next moves, the October EU summit is likely to be a decisive event: optimism from the EU could result in another wave of buying of the Pound, but failure to show sufficient progress could reverse the trend higher.

"Since 2015, when PM David Cameron proposed a referendum on EU membership, EUR/GBP has moved from around 0.70 to well above 0.90," says Falkenhall, inferring the huge fall in the Pound has been mainly due to Brexit.

The analyst believes Brexit risk could account for as much as 20% of Sterling's weakness suggesting significant potential upside if political conditions were to improve.

"Any progress or signs that negotiations will move on to phase 2 (talks on the future relationship), would probably reduce the risk premium and strengthen the GBP," says Falkenhall.

Economic Optimism

SEB cite the UK economy's continued resillience as a further reason to upgrade Sterling.

Falkenhall says that to be more certain the BoE will vote for another hike he would like to see evidence of a rise in household or capital spending, which have remained obstinately sluggish following the referendum and kept doves on the sidelines.

If spending rises then more members of the monetary policy committee would be comfortable hiking rates.

The strong labour market, however, is a reason to be optimistic, and recent CBI Retail Sales easily beat expectations in September, coming out at +42% when +19% had been forecast.

“The labour market remains strong and there is persistent job creation. The lowest unemployment rate since the early 1970s is likely to support household spending going forward and could potentially boost wages," says Falkenhall who sees a high chance of a rate hike in November, but it would probably be a one-off hike to undo the rate cut made after the referendum.

"There are signs of a renewed acceleration in household spending and for instance retail sales were stronger than expected in August, which was the third consecutive month with increased retail sales," adds Falkenhall.

Raising Pound's Forecasts

Overall the improvement in the prospects for Brexit, the shift in BoE policy and the signs of growth in the economy have led SEB to lower their EUR/GBP forecasts.

"We have lowered our EUR/GBP forecast to 0.87 by the end of Q4," says the analyst.  

This gives an upgrade on the Pound-to-Euro exchange rate to 1.1410.

SEB also lowered their 2018 forecast for EUR/GBP to 0.84, thus hiking the Pound-to-Euro exchange rate to 1.1880.

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