Markets Bet on Pound Sterling, Sell the Euro into Super-Thursday

Currency strategists lay out their targets for the Pound-to-Euro exchange rate as they bet the Bank of England will raise interest rates in 2017 and again in 2018.

What the Bank of England does to interest rates on Thursday, and says about future interest rate moves, will likely dictate direction in Sterling for the remainder of November and perhaps even beyond.

A 0.25% interest rate rise which would take the UK base rate from its current ‘emergency’ record low set at 0.25% is seen as a guaranteed outcome by markets. Therefore, if the Bank were to not raise interest rates, the Pound would plummet.

"There is a strong majority of economists expecting a rate hike and markets price a 88.4% chance of a rate hike. This means asymmetrical risks for sterling. Slight gain in case of rate increase, but heavy losses in case of an unchanged decision," says Piet Lammens, a trader with KBC Markets in Brussels.

But, this is a low-probability event precisely because the Bank knows it would disrupt financial markets and therefore the key question to ask from a currency perspective is whether the interest rate rise is a one-off, or whether one or two more subsequent rate rises will occur in 2018.

If yes, the Pound should rise, if no, the Pound should fall.

“The Bank of England is poised to join the Fed and the BoC in lifting policy. We do not think this will be a one-and-done event. We are tactically bearish EUR/GBP with 0.8755 the key support on the downside,” says James Rossiter at TD Securities who sees strategic opportunity in backing Sterling in the short-term as a result.

Also backing Sterling on the view that subsequent follow-up interest rate rises will be delivered in coming months is Jordan Rochester at Nomura:

“It is not clear to us that UK growth is about to falter suddenly. There may be further Brexit negotiation uncertainty, but there is arguably a lot of it already. Instead, we prefer to trade with conviction the idea that this is not a policy mistake and that the BoE is on a hiking cycle."

Nomura are looking for the Pound-to-Euro exchange rate to rise to 1.15 as a result of the view markets are too pessimistic when it comes to expectations for further interest rate rises and the bet is consensus is wrong.

For Rossiter at TD Securities, expectations for an higher GBP/EUR exchange rate also rest with the Euro side of the equation. Recall the Euro fell in the wake of the European Central Bank’s warning following their October policy meeting that Eurozone interest rates are likely to remain flat for a protracted period of time.

“Sterling in an interesting position,” says Rossiter, “rates markets have priced a November hike with near certainty. Against this backdrop, however, we think Thursday’s dovish ECB outcome opens the door for tactical downside in EUR/GBP into the decision.”

With the ECB moving to a more dovish footing, TD Securities see scope for EUR/GBP to accelerate lower to test support around 0.8745.

EUR/GBP at 0.8745 gives us a GBP/EUR exchange rate of 1.1435; so the potential gains are not exactly stratospheric.

“We see this as a near-term tactical position, however. With November priced with near certainty, the potential to extend further will depend on what signals the MPC sends about the future,” explains Rossiter.

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Chances of Second Rate Hike

It can’t be emphasised enough that what matters for Sterling on Thursday is communication regarding future policy moves.

“Our conviction of a second hike remains fairly high. This is driven, in part, by the Bank of England’s own analysis in their August Inflation Report,” says Rossiter. “We expect continued messaging that rate hikes will be dependent on the evolution of the economy vis-à-vis the Inflation Report projections.”

Meanwhile analysts at Barclays have entered a "long" bet on the Pound which seeks to take advantage of expected strength going into super-Thursday.

“We expect Governor Carney to suggest that this hike represents the first step in a gradual normalisation cycle driving GBP higher,” says Hammish Pepper at Barclays saying the market focus of this even will likely be threefold:

1) The actual monetary policy decision,
2) economic forecasts provided in its Quarterly Inflation Report, and
3) the assessment of wage dynamics and FX pass through.

The “core view” at TD Securities is that the MPC will hike once next week, and again in February 2018 (with a chance that hike slips to May 2018), before stepping back to the sidelines as Brexit negotiations near an (initial) finish line late next year.

Indeed, the thinking is that the risk of three hikes between now and the end of 2018 is greater than the risk of a single hike in November.

Not so, says Andreas Steno Larsen of Nordea Markets who says we are indeed about to witness a one-off cut owing to his observations on the state of the UK economy.

Larsen reckons the Bank is only cutting interest rates because inflation is well above their 2.0% target, all other indicators are suggest rates need to remain near record-low levels.

“If the Bank of England considers the input from more or less any other economic indicator, there is basically no reason to hike rates. House price momentum is weak, which slowly but surely will spill over to weaker consumption. So it may sound like we are stuck on repeat here, but don’t buy into the current Bank of England pricing. This week’s hike could easily end up as a one-off, which is also Nordea’s house view,” says Larsen.

Nordea Markets remain sceptical towards the GBP on a 4-6 month horizon and hence see downside in both GBP/EUR and GBP/USD.

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Barnier Boost

Sterling has caught a bid on Tuesday, October 31 on news that the EU's chief Brexit negotiator Michel Barnier said that he was ready to speed up talks with the UK.

Barnier said that the agenda and dates for the next round of Brexit talks would be set "in next few hours or days".

The UK had been seen urging Brussels to increase the tempo of talks by engaging in more face-to-face meetings to speed up the Brexit process and avoid a no-deal situation.

Markets are bidding Sterling as they believe the threat of a no-deal has been reduced, however slightly.

“We still forecast Sterling at $1.38 end-year ($1.40 end-2018). This may seem a stretch, but current levels ($1.32) encompass much bad news and any positive Brexit developments should support the Pound,” says Victoria Clarke, Economist with Investec in London.

Investec are forecasting the GBP/EUR to end 2017 at 1.15, where is expected to hover for the duration of 2018.