Pound-to-Euro Rate Forecasts: A Recovery is Likely say Danske & AFEX, but Patience is Required

- Pound-to-Euro exchange rate at 1.1368 at time of writing

- Danske Bank Maintain strategic position favouring rise in GBP vs. EUR

- Slowburning uptrend for exchange rate still alive

© Savo Ilic, Adobe Stock

The British Pound can expect to advance on its cross-channel rival over the course of coming months, but as has become traditional with the GBP/EUR exchange rate, significant moves require the exercising of substantial doses of patience.

According to two analysts we follow, Sterling remains in a position to advance on the Euro, even if the current period of underperformance might have further to run.

"EUR/GBP has hovered above 0.88 since the BoE meeting last week. With an August rate hike
still in sight in our view, we see relative interest rates as neutral for EUR/GBP for now, but expect GBP to eventually gain support from the rate channel," says Chief Analyst at Danske Bank, Christin Tuxen.

Tuxen is referring to the interest rate differential between the UK and the Eurozone, observing a theory that suggests money flows from where rates are lower to where they are higher as investors seek out greater returns.

Currently, this dynamic favours the higher interest rate environment of the UK. The Pound did however take something of a bashing on May 10 when the Bank of England declined to boost the UK's interest rate advantage even further via an interest rate rise.

However, markets are now eyeing such a move to come in August or November. Either way, the UK can expect one or two more interest rate rises before the European Central Bank opts to start raising their basic interest rate, which markets are scheduling for mid-2019 at this point.

On interest rate differentials alone, the medium-term therefore appears to favour Sterling and Danske Bank forecast the GBP/EUR exchange rate at 1.1360 in one month, and 1.1560 in three months.

But, "strategically, we are short EUR/GBP as one of our FX Top Trades for 2018 via a bought put spread and we would consider adding to this position on rallies above 0.8850," says Tuxen.

A strategic view is an actionable stance taken by an investment bank, typically recommended by analysts to their clients, and in the case of those looking at this exchange rate from the GBP/EUR angle, this suggests that any moves below 1.13 are to be viewed as an opportunity to buy Sterling in anticipation of a move higher.

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And, there is also a technical argument to be made in favour of Sterling.

Trevor Charsley, an analyst with AFEX, the global payments and FX risk management specialist says it appears to him that recent Sterling weakness still effectively looks part of an ongoing range (given a very shallow angle of ascent in monthly terms) and on this basis downside risk should be relatively limited."

Technical studies are studies of the underlying structure of a market, and they can often provide strong clues as to where a currency is headed based on past behaviour.

Charsley notes there is certainly some scope for some further declines in Sterling-Euro, but they are liable to remain limited in nature:

"A breach of nearby 1.1300/10 support might well extend the past few weeks retracement somewhat nearer 1.1200 but preliminary evidence suggests any such sell-off will struggle much below 1.1250.

What we find notable is the trend-line that appears to be guiding Charsley's thinking; it tells us that the preferred route forward is ultimately higher.

Should Sterling find support and stage a recovery, Charsley says a break of resistance at
1.1450 should allow for another test - and potentially a breach - of prior 1.1600 highs.

It is worth noting that the upward trend line is a very flat one, which is suggestive of a very slow pace of appreciation, therefore we find this technical view to gel quite nicely with the timeframes suggested by Danske Bank - those wanting a stronger Pound must exercise patience.  

Analyst Piet Lammens with KBC Markets in Brussels meanwhile reminds us that "Brexit remains a wild card, but unless the process swirls completely out of control, we expect EUR/GBP to hold the 0.89/0.86 trading range."

The 0.89/0.86 range in EUR/GBP corresponds to a range between 1.1230 and 1.1630 in GBP/EUR.  

"Decent UK economic data might make investors reconsidering the chances for an August rate hike," adds the analyst.

With this in mind, key to the immediate outlook is the shape of UK employment and wage data, due out on May 14. A strong beat of expectations here would certainly see the belief that the worst for Sterling might just be over.

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