The Pound is Going to go Below Parity vs. Euro says Europe's Largest Asset Manager

The City of London is tipped to lose passporting rights into Europe, which is expected to negatively impact on the UK's overall trade position and hurt the Pound. Image © IRStone, Adobe Stock

Amundi - the asset manager that boasts €1.4 trillion worth of assets under management - have warned that the British Pound faces significant downside should the kind of Brexit deal they are expecting be delivered.

"Our base case scenario foresees an intermediate relationship, with free trade in goods but only very partial passporting in financial services," says Didier Borowski, Head of Macroeconomic Research at Amundi, Europe's largest asset manager.

This deal for passporting is crucial owing to the significant portion of export revenue generated by financial services and Amundi warn their base-case envisages the UK ending up with less passporting rights than Switzerland currently enjoys. 

The risk that financial service activity fades following Brexit and is a key factor why Amundi are forecasting the Pound-to-Euro exchange rate to fall below 1.0.

The call comes as the UK and EU lock horns in the second round of Brexit negotiations that are intended to settle the question of an interim transitional Brexit period that covers a period of two years following the EU's exit from the EU which will allow the two sides to fully prepare for a the future relationship.

Yet, even before trade negotiations have begun, tensions are simmering as to the kind of future trading relationship the two sides will enjoy.

It is quite clear the EU appears open to a free trade agreement on goods but are reticent to extend this generosity to the trade in services. Critics of this stance point out that this is because the EU is a net exporter of goods while the UK is net exporter of financial services.

Ian McCafferty, external MPC member of the Bank of England, stated in December 2016 that “trade negotiations traditionally are not normally concluded until ‘one second before midnight’, and the exit negotiations with the rest of the EU are unlikely to be much different. As a result, the wide range of possible outcomes means that levels of uncertainty are likely to remain elevated for a considerable period.”

"We must stress that negotiations are only just starting and one might bear in mind that trade negotiations are quite hard to settle," says Borowski.

As such, Amundi caution there is still much uncertainty and there is no scenario that can currently be ruled out, even though they believe that chances of a hard Brexit are far less likely.

Why a Financial Services Deal is Critical for the Pound

Foreign exchange forecasters typically find themselves weighing up a variety of scenarios pertaining to multiple inputs that determine a currency's value to determine a future price.

At the present time it will come as no surprise to readers that most analysts place the Brexit outcome at the top of the list for future moves in the Pound.

Amundi have worked through four possible Brexit outcomes and assigned a likelihood to each one and worked out the potential impact of the two most likely outcomes on assets, such as the Pound.

Scenario 1: 50% Probability:

The most likely outcome is an intermediate relationship, with free trade in goods and a number of sectoral agreements for passporting services (with less access to the EU market of financial services than what Switzerland enjoys). 50% probability.

"This limited access is the price the UK would pay for imposing major restrictions on movement of people and paying only limited contributions to the EU budget," says Borowski.

Scenario 2: 25% Probability:

This is the soft Brexit outcome that sees a deal that is similar to existing European Economic Area relationships being struck. This allows access to the single market (only with few exceptions, including some in financial services) and only minor restrictions on movement of people.

"This scenario would be the most positive for the UK economy, but could meet opposition from Brexiteers arguing that it has given the UK almost no additional flexibility in comparison to EU membership," says Borowski.

A hard Brexit is meanwhile assigned a 15% probability and a no Brexit assigned a 10% probability.

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What Will Happen to UK Economic Growth?

Under scenario 1, UK GDP is forecast at 1.6% by the end of 2018 and 1.7% by the end of 2019.

This contrasts to current IMF economic forecasts for 1.5% for both 2018 and 2019.

"When it becomes clear that financial services won’t be provided to Europe from the UK as before. This outcome would add downward pressure on the GBP again," says Borowski.

Under scenario 2, Amundi forecast economic growth of 1.8% and 2.0% for 2018 and 2019.

"With the UK accessing the single market for services too, uncertainty will diminish progressively and the GBP would appreciate, particularly in 2019," sys Borowski.

Forecasts for the Pound

For Amundi, the Pound’s path is still very uncertain as under the two scenarios the perspectives for the currency can diverge dramatically.

What is important to understand is the UK's current account deficit - i.e. the deficit that arises because the UK imports more than it exports.

To keep Sterling stable the country must attract investments from foreign investors - the inward flow of currency creates and offset to the outflow of currency the derives from the export-import imbalance.

Turn off the taps of inward foreign investment and the Pound is left exposed.

"Running persistently large current account deficits increases the vulnerability to a sudden stop of capital inflows if market conditions deteriorate. The UK’s trade surplus in financial services has largely helped to counterbalance its large trade deficit in goods," says Borowski.

For Amundi then, drastically restricting financial services passporting could lead to a further deterioration of the current account deficit that would harm the Pound.

"If this outcome was to materialise we would expect the Pound to depreciate vs. USD to 1.30 and to a larger extent vs. EUR, to around 0.95."

Scenario 2 - a.k.a soft Brexit - is however "remarkably more benign than the base case". In such an outcome Amundi would expect markets to begin re-assessing the Pound according to its fundamentals, removing most of the “political” connotation the currency has had since the EU referendum in June 2016.

The pound could therefore move gradually towards its fair value, which currently stands at 1.52 vs. USD. We have requested a specific Pound-to-Euro forecast for this scenario but

Interestingly, for those watching stock markets, the latter, more benign scenario could actually correspond with a 1% fall in the value of the FTSE 100 by June-2019.

This is because the FTSE 100 does show a sensitivity to moves in the Pound and a strengthening Pound could actually hit foreign demand for UK stocks.

Under the base-case scenario 1 however the FTSE 100 is seen 11% higher by June 2019.

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Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here.