Pound Sterling Forecast to Climb vs. Euro into Year-end by Credit Suisse

But "severe downside" risks must be guarded against warn analysts, given the binary nature of risks associated with Brexit talks warn analysts.

The Pound-to-Euro exchange rate could see a recovery during the coming weeks, according to forecasts made by investment bank Credit Suisse, as Brexit talks are likely to move forward faster than the market expects.

Any positive surprises regarding the extent of progress on Brexit over coming days and weeks are expected to play into the hands of Sterling, which appears to be a 'political currency' at present.

The call comes as Sterling remains above the €1.11 area despite a recent surge in the value of the Euro, a sign of persistent stubborness by the Pound as traders view risks evenly balanced between the topside and downside.

Above: The Pound-to-Euro exchange rate is uncomfortable below 1.11.

How positive your view is on the potential progression of Brexit talks will likely influence your viewpoint on where Sterling is headed next - optimists will naturally see the prospect of Sterling appreciation, while those wary of talks stalling will understandably hold a more negative viewpoint.

"In the near term UK politics will likely be the main driver of GBP. In fact, GBP’s reaction to UK politics and our Brexit stress tracker is rising again," says Yujiro Goto of the Global FX Strategy desk at Nomura.

European Union negotiators have so far said “sufficient progress” is still needed to fill the budgetary black hole expected to open up after the UK departs the union, and to cover the cost of projects agreed in the past but not yet undertaken.

This has led to a cautious approach toward Sterling by markets that see the risks of disappointment as being elevated.

“We are still taking as our base case a view that the UK finds a way to promise sufficient clarity on the financial settlement to allow for a positive surprise, which is the key to our relatively bullish GBP forecasts,” says Shahab Jalinoos, a foreign exchange strategist at Credit Suisse.

This position might just have become a little more credible if latest headlines are to be believed.

German MEP Manfred Weber told reporters Thursday that Prime Minister May is close to increasing the UK’s existing offer to Brussels in order to move talks along. The statements came after Weber held talks with PM May and cabinet ministers in Downing Street.

eber who leads the European People’s party (EPP) and is said to be a close ally of German Chancellor Angela Merkel, said he had witnessed a substantial shift in the British approach which might now allow EU leaders to move on to the next stage of negotiations.

Following a meeting held with Theresa May, David Davis and Amber Rudd, Weber notes:

“I am one of the more sceptical partners from the European parliament side on Brexit negotiations and ongoing progress but I have to say that after my meetings today my main message is that I am more optimistic that there is progress; that there is the will to see progress.

“The message is that the will is there."

Until such “progress” is made, European negotiators are unable to discuss the future trading relationship or any transition agreements, but if all is to be agreed in time for the UK’s scheduled departure date in March 2019 those talks are seen as needing to begin before year-end.

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Weber’s statement has since been described by members of the Downing Street press office as “yet more speculation”, according to a Reuters report.

Nevertheless, the prospect of a positive surprise on the Brexit front remains a key upside risk to the Pound. The movement of talks onto the issue of trade and the future relationship in early 2018 would serve Sterling well.

“Such a development would be a major win for the government given current market perceptions of its competence, even if for a period it would raise more noises among hardline Brexiters angered by the promises made,” says Jalinoos.

Negotiators have said they will need to have received such an offer before the end of November so that it can be presented to the European Council in time for December’s summit, which takes place on the 14th and 15th.

Should negotiations not move forward at the December summit then the next time the European Council will have the opportunity to vote on them will be at the March 2018 summit.

Furthermore, the question of Prime Minister May's position at the head of government is thought by Credit Suisse to be more secure than many others in the market assume.

“If Conservative hard Brexiters push too hard to remove May without wider party support, the end outcome may be the collapse of the government and a victory for the opposition Labour Party, Jalinoos adds. “This knowledge is probably why there has been no leadership challenge till now, and likely not for the foreseeable future either.”

Sterling fell at the start of the week on reports that up to 40 members of her parliamentary party were prepared to sign a letter of no-confidence in May, 48 signatures would be required to trigger a leadership election.

The issue has since died down.

Severe Downside Risks

“If we are wrong, and either the government falls or quite simply no acceptable offer can be put forward to the EU, we acknowledge there is severe downside risk to our GBP forecast profile,” says Jalinoos.

If talks about trade and transition do not begin by December, fears are that some financial firms will begin preparing for the worst, which could see non-EU firms begin shifting some of their resources elsewhere.

Given the relative size of the financial sector in the UK, accounting for a high single digit percentage of all jobs, campaigners have feared this might hit the economy.

However, Pound Sterling Live has reported that fears of a financial services exodus from London to the continent might also be overblown, with a number of US banks said to be looking to 'branch-back' operations, which might enable them to keep their big operations in London.

“So that leaves many market participants to hope that even in a worst case (i.e. in case of a super hard Brexit) the economic damage will be limited so that there is no fundamental reason for GBP weakness. I follow this view,” says Ulrich Leuchtmann, head of foreign exchange strategy at Commerzbank.

Potential weakness for Sterling might also be found in the form of a slowing UK economy.

“On the UK data front, news remains mixed, with signs of a housing, retail spending and inflation slowdown offset by still-strong employment and a likely external boost from the strength of the global (and ironically euro area) economy,” says Jalinoos.

Forecasts

Jalinoos predicts that economic data will play second fiddle to concerns over the trajectory of Brexit negotiations over the coming weeks, with market reactions constrained to an intra-day phenomenon.

Credit Suisse forecasts the Euro-to-Pound rate will close the year at around 0.88 pence, which implies a Pound-to-Euro rate of 1.1360.

This is nearly 2% above the 1.1150 market price seen Wednesday.

The Pound-to-Dollar rate, on the other hand, is seen closing the year at 1.36, which is some 31% above the 1.3180 market price seen Wednesday.

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