British Pound Hovering Near Critical 1.11 Support Level Against the Euro

Image © Rawpixel.com, Adobe Images

- GBP at lowest level in 8 months vs. the EUR

- Support levels centred around 1.11 could offer Sterling short-term respite

- Any strength in the Pound likely to be sold says leading strategist

Pound Sterling is being tested at the key 1.11 level - the bottom of the range it has maintained since September 2017.

The range, between 1.11 at the bottom and 1.15 at the top - was the level markets were happy to maintain Sterling-Euro at while Brexit negotiations were thrashed out by EU-UK leaders.

But, the level was ultimately contingent on some form of amicable deal being sealed by Brexit day in March 2019.

That the 1.11 bottom appears to be threatened suggests markets are losing faith that such a deal is indeed possible.

The fear for those looking for a strong Pound is that the break below 1.11 and out of the long-held range could effectively open the door to a more rapid descent.

"Sterling unravelling now against both the USD and EUR. Independent weakness is evidence of no-deal Brexit risks being priced in," says Viraj Patel, a foreign exchange strategist with ING Bank N.V.

The mechanics behind move lower appears be the desire by those with currency exposure to buy protection against a 'no deal' Brexit. Data reveals the cost of hedging against a 'no deal' Brexit by corporates looking to protect their currency exposure continue to rise "relentlessly" says Richard Pace who sits on the Thomson Reuters currency desk. "Nine-month and one-year contracts have seen relentless demand."

It is these longer-dated options which "truly reflect the rising concern about a no-deal Brexit," says Pace as their expiries falling after the planned March 29, 2019 Brexit date and therefore capture any related volatility and deeper GBP declines.

"No fresh catalysts, but sterling trades persistently weaker, possibly as investors and businesses are bracing for the seemingly rising risks of a “no-deal Brexit” impact," says John Hardy, Head of FX Strategy at Saxo Bank. 

The GBP/EUR exchange rate is now testing the well signposted support level of 1.11; we could therefore see selling pressures temporarily ease as sellers exit the market and book profits.

Mazen Issa, Senior FX Strategist at TD Securities, says GBP/EUR is "re-calibrating" to the downside with a move towards 1.11 which he describes as "a notable but likely level."

1.11 forms the bottom of a range treaded by Sterling since September 2017, and therefore there is a high likelihood that there will be enough buying interest in the market to support the Pound around these levels.

However, at this stage betting on a recovery is akin to catching a falling knife: the Relative Strength Index - a popular indicator of momentum - in the market is sitting at 34 (see the bottom pain in the graph above) and is therefore advocating for further losses.

Analysts at ING believe Sterling can go lower and have got EUR/GBP pencilled in for a move up to 0.91-0.92, which implies a GBP/EUR exchange rate moving down to 1.0990-1.0870.

ING's Viraj Patel stresses the target for EUR/GBP is one that reflects "peak no-deal Brexit uncertainty and assumes no further escalation in the trade war. Could be worse if trade war does escalate."

Among the notable moves in #markets in #Europe: #Sterling is another 0.6% weaker, now trading below 1.29. #economy #fx #forex #currency #gbp #pound #brexit pic.twitter.com/5U78CQ6x1O

— Mohamed A. El-Erian (@elerianm) August 8, 2018

Of course markets never trade in a straight line and trends are often interspersed with periods of strength, and we would of course remain open to the prospect of a recovery in the Pound at some point.

The important thought to take onboard though is that any strength in Sterling is likely to be short-lived in nature.

"With summer conditions in full force, the MPC a long way from another hike (we anticipate another 9 months from now at the earliest), we look for domestic politics and external factors for GBP direction," says TD Securities' Issa. "We think that the market will be inclined to sell GBP rallies."

The British Pound suffered a decline to its lowest level in eight months on a ratcheting up of fears for a 'no deal' Brexit that would see the EU and UK slide into a WTO trading partnership when Brexit occurs in March 2019.

Prime Minister Theresa May is stepping up the government’s preparations in case Brexit negotiations break down and the country crashes out of the European Union without a deal.

May is planning a top-level meeting of her cabinet ministers early in September specifically to discuss how to ready the U.K. for a no-deal Brexit, according to a report on Bloomberg.

The report adds, a seperate working group of senior government officials is being convened to devise ways to keep the Irish border free of customs checks and police even if there’s no withdrawal agreement, one of the people said

Both sides are clearly far enough apart for the UK to seriously countenance a 'no deal' Brexit, a sentiment increasingly shared by markets.

What we think is most likely is that both sides will extend deadlines to allow themselves to continue talking - but this is no good for those who want a stronger Pound as it merely extends the period of uncertainty and puts a recovery by the currency on hold.

"We expect political noise to increase and thus no further rate action to be taken before March 2019, when the Brexit officially takes place," says David Alexander Meier at Julius Baer in Switzerland. "We remain neutral on the pound sterling until there is greater visibility on the Brexit question."

Advertisement
Get up to 5% more foreign exchange for international payments 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

Pound Sterling to Fall to Parity with the Euro

While 1.11 looks to be a near-term target for the GBP/EUR exchange rate, we must be aware that the markets are likely to push the value of Sterling sharply lower should a 'no deal' Brexit actually materialise.

"It would probably drop a lot more if fears of a “no deal” materialised. After all, investors still seem to be assigning a fairly low probability to this outcome," says John Higgins at Capital Economics.

EU and UK leaders are eyeing the October 18 European Council Summit for a deal to be struck in time for the March 2019 Brexit day. But, with limited time left to negotiate and increasingly entrenched positions on both sides of the table markets are inevitably becoming increasingly concerned no deal will be reached.

"Although it is not our central view, we would anticipate that a hard Brexit would drive EUR/GBP towards parity and this would trigger another round of damaging inflationary pressures in the UK," says Jane Foley, head of FX strategy with Rabobank.

Foley says markets are however ultimately prepared to see some brinksmanship from politicians who will keep on "pushing, pushing and pushing" their position "until finally they sign on the bottom line".

Rabobank expect "political uncertainty to erode support for GBP in the coming weeks and expect EUR/GBP to trade back up to 0.89 on a 1 month view."

An EUR/GBP exchange rate at 0.89 gives a Pound-to-Euro exchange rate of 1.1236.

Therefore the market is forecast to maintain current levels over the coming month.

We wrote at the start of this week that Sterling would likely consolidate in the month of August as Brexit headlines dissipate owing to politicians on both sides of the channel taking their summer holidays.

Advertisement
Get up to 5% more foreign exchange for international payments 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