GBP/EUR Forecast Downgraded as Rabobank say Uncertainty to Last Beyond Brexit Day in March 2019

- Pound-Euro forecast downgraded from 1.19 previously

- PM May keeps the government together, but can't squeeze out a unified position

- But beware a unified government position following Chequers 'away day' in early July

Image © SlayStorm, Adobe Stock

The current thinking on global foreign exchange markets goes along the lines that Pound Sterling is undervalued when compared to the economy's performance, and this undervaluation is a direct side effect of the ongoing uncertainty concerning the future trading relationship between the UK and EU.

Clarity is needed, and until such a time as that clarity is forthcoming foreign exchange traders will be content to sit on the sidelines and let the Pound meander on a sideways-orientated range against the Euro.

"In light of the sheer degree of political risk it is surprising that volatility in the pound has not been higher in  recent weeks," says Jane Foley, a foreign exchange strategist with Rabobank - the Dutch based multi-national financial services provider.  This sentiment is echoed by Gajan Mahadevan, a Quantitative Strategist at Lloyds Bank:

"There is a high degree of uncertainty surrounding key binary-type event risk (Brexit), reducing the medium-term directional conviction among corporate and institutional participants."

But expectations are for a significant amount of the fog concerning the future relationship between the EU and UK to evaporate by the time the UK exits in March 2019; this is in turn widely expected to afford the Pound a chance at staging a recovery.

However, new analysis from Rabobank suggests that this assumption is in fact too optimistic and foreign exchange markets will still be contending with uncertainties by the time this date comes around, and even beyond Brexit day.

That uncertainty surrounding the future relationship will still be prevalent in 2019 will surely ensure the Pound stays at suppressed levels, and Rabobank have as a result announced a downgrade to their targets for the currency.

May Keeps her Government Together, but Where are the Details?

The blame for slow progress in Brexit negotiations, and a growing presumption that no major breakthrough will be forthcoming before March 2019 is largely laid at the door of the UK government which is run by a divided Conservative party.

Thus far Prime Minister May has maintained the party's unity and won key votes in parliament, which we believe affords her more credit political commentators are willing to give her credit for.

While May might be displaying astute political management skills, markets lament that there is still no unified policy position on key areas of Brexit negotiations forthcoming from the government.

"Ms May has managed to fend off two rebellions in the House of Commons this month allowing the EU (withdrawal) bill to be passed. These episodes were linked to whether or not parliament should have a meaningful vote on the Brexit deal the government managed to negotiate. As it stands, however, there is scarce detail regarding government’s negotiating position, never mind what the final outcome could look like," says Foley. 

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We warn readers to however be aware that a key 'away day' for the government's top decision making body, the cabinet, is to be held on Friday, July 6. The 'away day' to be held at the Prime Minister's official Chequers residence and an official White Paper covering unanswered questions should result from the meeting.

Key questions to answer pertain to the Irish border and the shape of the future customs agreement.

It could well be the case that should cabinet unity break out the Pound pops higher as expectations for a more rapid progress to a final Brexit deal becomes evident.

Foley is however sceptical.

"Time is running out before Brexit is scheduled to start in March 2019," says Foley, "EU  officials have recently warned that they must prepare for every eventuality, including the risk that the UK could crash out of the EU without a deal. Given this backdrop there is heightened risk that investment in the UK could stall and that GBP could be exposed to more downside pressure."

The Bank of England a Source of Support

One positive force that could counter the Brexit-induced weakness in Sterling that is expected is the Bank of England, where expectations are now sitting just below 50/50 for an August interest rate rise, while a rate rise by November is almost a done deal according to pricing on money markets.

"In the June policy meeting the BoE positioned themselves well. Chief economist Haldane joined the usual two hawks in voting for an immediate rate rise. This forced the market to consider more seriously the risk of a rate hike in August. The result was a welcome boost to the value of the pound without the Bank positioning itself in a corner as it had done earlier in the year," says Foley.

For these expectations to be met, the UK economy must however start to put in some consensus-busting performances as it returns to a more robust rate of growth, something that was amiss in the first quarter of the year and led to the Bank skipping a May interest rate rise.

Foley adds that the Bank will be looking at more than just the economy - the value of the Pound itself could be a reason behind any interest rate rise.

The Pound "is crucial to the MPC," says Foley. "If the pound were to remain well supported, it would reduce the risk of another bout of imported inflation... the Bank of England could offer support to the pound if risk of a 2018 rate hike can be nurtured."

Forecasts for the Pound

Rabobank maintain a strong Dollar assumption over coming months, expecting the rally in the Greenback that has been in place since mid-April to extend.

As such, "although we see a strong chance of an August rate hike from the BoE, against the backdrop of a firm USD we still see risk of cable retreating below the 1.30 level by the end of the year," says Foley.  

Against the Euro, the Pound should end the year lower than at current levels, but importantly, a downgrade to the forecast has been executed on the 12 month timeframe.

"We continue to expect a moderate softening of the pound vs. the EUR towards EUR/GBP 0.89 into year-end." This gives a GBP/EUR exchange rate of 1.1236.

Rabobank have raised their 12 month EUR/GBP forecast to 0.87 from 0.84, this gives a Pound-to-Euro exchange rate of 1.15, down from 1.19 previously.

"Previously we were of the view that clarity on Brexit would lift the Pound next year.  Now it seems likely that uncertainty about the eventual trading relationship between the EU and the UK will persist well after the March 2019 Brexit commencement date," says Foley.

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