Pound-Euro Rate as "Dull as Dishwater" says HSBC's Bloom

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The British Pound may be stuck in a rut against the Euro for now, but HSBC say the inevitable breakout will be to the downside.

Pound Sterling is back under pressure at the start of the new month with Brexit negotiations looking to be going the wrong way for the UK currency.

However, if we take a step back and look at the charts, the Pound-to-Euro exchange rate is in fact not in remarkable territory. In fact, it is slap-bang in the middle of its long-term range against the Euro; indeed the exchange rate appears to be stuck in a rut with the 1.13 level being a fulcrum in a multi-month range for the exchange rate.

Those hoping for a stronger Pound will be frustrated by the exchange rate's inability to get moving, but one consolation to walk away with is that at least the Pound looks well protected against major weakness.

"I look at FX, and if you look at Euro-Sterling it's done absolutely nothing, it's a crushing ball, so yeah, we talk about it but FX is saying show me the money, show me a deal," says David Bloom, HSBC's head of foreign exchange research.  

Bloom says the market is likely to remain caught around current levels until such a time as some real news on Brexit is made forthcoming. "The UK is renegotiating its position with the EU, let's look at Sterling against the Euro and if you look at that it's as dull as dishwater," says Bloom, "we're waiting for something to happen".

"It looked like Sterling was weakening, weakening, weakening, something happened, it strengthened and if you look at the charts since September last year it's done nothing," adds Bloom.

The analyst adds the exchange rate has been "in the tightest range you can possibly get in foreign exchange" and the market is just not going to get excited until we get a deal.

However, HSBC do believe that ultimately the exchange rate will break out, and their thinking is that it will be to the downside.

"There is heightened political tension around the UK’s withdrawal from the EU and the transition agreement. This political pressure is unlikely to ease; we see GBP-USD falling to 1.34 this year and EUR-GBP rising to 0.93," says Dominic Bunning, Senior FX Strategist with HSBC in London.

A Euro-to-Pound exchange rate at 0.93 equates to a Pound-to-Euro exchange rate at 1.0750.

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Tensions Rising, but Markets Still Waiting for Substance

The Pound fell on Wednesday, February 28 after the European Union released a draft legal text which would oversee the conditions of the UK's withdrawal from the EU. The text reopened concerns surrounding the question of the Irish border and poses fresh questions as to the likelihood of the EU and UK agreeing a transitional agreement by the end of March which has been set as a deadline.

We however believe this is typical of the posturing engaged in by both sides and enough progress will be achieved for a transitional deal to be reached; and from looking at the GBP/EUR charts it would appear markets agree.

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Analyst Viraj Patel at ING Bank believes GBP/EUR is unlikely to offer much excitement until some real progress or failure is made in Brexit as they have learned to avoid the speculative moves that befell the currency in 2017.

The analyst told clients in a note that "it’s clear the weak and almost ‘half-life’ like Pound is looking for any positive reason to transform into a better version of its self, "with the currency’s resilience of late indicative of a different Brexit trading environment relative to the more dystopian-like one observed over 2017".

"Part of this new environment is seeing GBP investors opting to trade off Brexit facts rather than Brexit speculation – with the latest CFTC positioning data showing that real money investors did not add to their net short GBP bets, despite the prospect of heightened Brexit uncertainty in the coming weeks," adds Patel.

Analyst Lucy Lillicrap at AFEX - a foreign exchange brokerage - says the response of prices to resistance at 1.1600 and the 1.1200 area support is seen as key insofar as determining medium term directional bias. "Further choppy range extension looks more feasible while focus remains elsewhere," says Lillicrap in a recent technical analysis of the exchange rate.  

However, Lillicrap suggests recent consolidation could of course also be used as a base/platform from which to enable fresh GBP gains over coming weeks.

Société Générale analyst Kit Juckes tells clients that there remains little "encouragement for Sterling bears" in the current environment.

Juckes makes the call having observed that the GBP/EUR exchange rate is tracking the difference between yield on German and UK bonds - and the findings confirm the exchange rate is well placed at current levels.

Indeed, at the time of writing the Pound-to-Euro exchange rate is quoted at 1.1395 - close to where it has traded for much of the past five months as neither the Euro nor the Pound seem to be capable of gaining the upper hand.

As we can see below, the EUR/GBP is highly correlated with dynamics in UK and German bond yields:

But, if we look at EUR/USD we see an example of where such a relationship has broken down:

Until this relationship breaks down as relates to EUR/GBP the case for a steady exchange rate appears intact.

Bond yields levels are largely a function of central bank policy; therefore policy at the Bank of England matters and of late we have heard a number of updates from Bank of England policy members that appear to be supportive of higher UK yields.

Last week members of the Bank of England Monetary Policy Committee appeared before Parliament's Treasury Select Committee and the takeaway was deemed positive for Sterling owing to a more 'hawkish' than anticipated tone being struck.

Then over the weekend another 'hawkish' development occurred as Deputy Governor Sir Dave Ramsden, says he sees the case to raise interest rates sooner than he previously thought.

This is significant - Ramsden had previously voted against raising interest rates when the Bank moved to raise rates 0.25% in November.

It suggests the door to higher interest rates has opened a little wider which in turn pushes UK yields in a direction that is supportive of the Pound.

It's "helped the pound despite the usual depressing Monday morning Brexit headlines," says Juckes. Further the developments provide "no encouragement for Sterling bears, other than to argue for going long EUR/GBP close to 0.87."

Going long EUR/GBP close to 0.87 implies selling the Pound against the Euro at 1.15.

In short - the Pound can go higher back towards the top of its multi-month range before capitulating again.

More of the same then.

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