Pound-Euro Recovery Reliant on Continued Turkish Turmoil, Analysts Maintain we Should Expect Losses over Next 3 Months
- As long as the Turkish crisis rumbles on, GBP/EUR should be supported.
- But strategists still favour Euro over Sterling on a three month horizon.
- Sterling is now at the proverbial 'fork in the road' say UBS strategists.
Turkish President Recep Erdoğan won't allow the central bank to do what it must to stem his country's financial crisis. Image © Paul Morigi Photography / Brookings Institute. Reproduced under CC Licensing
The British Pound has been thrown a lifeline by a slide in the Euro which has displayed a negative response to the escalating Turkish financial crisis and subsequent run on the Lira.
And as long as the crisis remains alive we could well see GBP/EUR remain supported; at least until Brexit headline risks start to heat up once more.
Concerns that Eurozone banks could come under pressure in the event of a Turkish banking crisis allowed the Pound-to-Euro exchange rate to recover from monthly lows at 1.1076 to back above 1.12; indeed the UK currency has often displayed safe-haven tendencies in times of Eurozone stresses.
The recovery in the inter-bank market rate to 1.1195 has seen the rate for international payments offered by banks recover into the 1.0880-1.09 bracket while independent specialist money transfer providers were seen offering a best above 1.1120.
"Sterling is actually outperforming the Euro as the UK is seen as less exposed to Turkey. Technically, the EUR/GBP rally looks nearly reversed here," says John Hardy, chief currency strategist at Saxo Bank, referencing a recent retracement of Euro strength.
The move allowed a moment of brief respite for those looking to sell out of Sterling and buy into Euros; but the warning we are hearing is that this recovery is likely to be fleeting in duration as the overall narrative on the Pound is one of decline.
"If Turkey can turn the sentiment in the near term, this pair may pull back higher and go back to being driven by the Brexit narrative," says Hardy, of the EUR/GBP exchange rate, warning of a potential imminent return of Sterling weakness.
For now though, the situation in Turkey remains fluid as the only tangible action we have seen from authorities is a promise by the Central Bank of the Republic of Turkey has promised to "take all necessary measures" required to support the financial system.
The CBRT cut TRY RR ratios by 250bps on all maturities and cut FX RR ratios by 400bps for some maturities - i.e. the Bank has lowered the amount commercial lenders must park with it.
The CBRT says the move will provide TRY10bn, US$6bn and US$3b equivalent in gold of additional liquidity. There was however no mention of higher interest rates, it said all options were on the table.
"Just as King Canute could not stem the waters by ordering the tide to stop, a country with a 6% current account deficit and 15% inflation will be powerless to stop its bonds and currency sliding without hiking interest rates and/or restricting capital outflows," says Kit Juckes, a foreign exchange strategist with Société Générale.
Indeed, there is certainly a sense that the Turkish crisis might linger for longer.
"A textbook currency crisis is unfolding in Turkey. Large and widening current account deficit, check. Growing foreign currency debt, check. High and rising inflation, check. Constrained monetary policymaking, check," says foreign exchange analyst Alvin Tan, also with Société Générale on London.
Therefore, it looks like a series of aggressive interest rate rises are required to help shore up the Lira, however we know that Turkey's increasingly totalitarian president Erdogan is loath to allow interest rates to go higher.
And herein is the real source of Turkey's woes: a totalitarian leader who believes he has the right, and ability, to hold all the leavers of power in Turkish society and the Turkish economy.
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Lira Stabilises as Markets Await Developments
The Lira stabilised and the Euro found a surer footing in sympathy on Tuesday, August 14 as markets awaited further developments out of Turkey.
The country's President Erdoğan maintained Turkey is the target of an economic war, and has repeated calls for Turks to sell their Dollars and Euros to shore up the national currency.
"Together with our people, we will stand decisively against the dollar, forex prices, inflation and interest rates. We will protect our economic independence by being tight-knit together," Erdoğan told members of his AK Party in a speech.
"We will impose a boycott on U.S. electronic products. If they have iPhones, there is Samsung on the other side, and we have our own Vestel here," he said, referring to the Turkish electronics company, whose shares rose five percent.
This is simply tinkering around the edges and doesn't change the facts: The Turkish economy is structurally vulnerable and in need of deep-seated reform, while short-term interest rate rises are almost certainly required to stem the outflow of capital.
Erdoğan’s ongoing defiance meanwhile confirms he is not in the mood to resolve the diplomatic impasse with the US.
Next 3 Months: Euro Still Favoured over the Pound
While there is evidence the Turkish crisis has the potential to extend in the short-term, and therefore provide a support for the Pound-Euro exchange rate, Tan says he still favours further Euro upside against the Pound given the escalating Brexit risks.
There is therefore certainly the sense that these spikes of strength in Sterling are strictly time limited in nature.
Foreign exchange strategists with Commonwealth Bank of Australia have meanwhile told clients that Euro exchange rates will not suffer lasting damage from the Turkish financial crisis. "We do not anticipate a change in the ECB's monetary policy stance because of Turkish economic and political developments. Nor do we believe EUR/USD will decline significantly because of events in Turkey."
Any emergent stability in the headline EUR/USD exchange rate will in turn provide stability for the EUR/GBP exchange rate we believe and help stem nip any Sterling advances in the bud.
Sterling at a Fork in the Road
The British Pound has continued to weaken through August despite the Bank of England raising interest rates on August 02; a move that should have aided the Pound higher if textbook foreign exchange market dynamics were in control.
With little time to go until March 2019, market focus is now shifting to the March 2019 Brexit deadline with a 'no deal' expected to undermine Sterling over the medium-term.
"Once again, the GBP is facing the proverbial 'fork in the road'" says Daniel Trum, a Strategist with UBS in London.
UBS believe it is more likely than not that a deal will be eventually found, so that EUR/GBP can fall to 0.88 in six to 12 months.
"However, for the next three months, we expect EUR/GBP to rise to 0.90 and slightly above," says Trum. (EUR/GBP at 0.88 gives GBP/EUR at 1.1136 and 0.90 gives 1.11).
Graphic courtesy of UBS.
Trum argues several factors are to conspire against Sterling over the three month time-frame: rising Brexit uncertainty, investors unwinding 'long' Sterling positions, and the Bank of England likely being done with rate hikes for the next 12 months.
Therefore, those who can wait a matter of months for a stronger Pound could well be rewarded as UBS reckon the longer-term picture calls for a stronger GBP/EUR exchange rate.
Fundamental drivers - such as purchasing power parity (PPP) - suggest the pound-to-Euro exchange rate should be trading as high as 1.25.
Graphic courtesy of UBS.
Furthermore, the Eurozone economy is no longer outgrowing the UK as strongly as it did in 2017.
"Hence, provided there is no cliff-edge Brexit, GBP should be in a good position to keep its level against a rebounding Euro," says Trum.
Meanwhile, one of the UK's most recognised high-street lenders - Lloyds Bank - have said they expect Pound Sterling to recover over coming weeks as the prospect of a 'no deal' Brexit fades.
With the Pound and Euro both softening against the US dollar, Lloyds observe GBP/EUR remains confined to a narrow medium-term range.
The range is broadly seen as lying between 1.11 on the downside and 1.15 at the top and defines the levels traded by the Pound-to-Euro exchange rate since September 2017.
"For now, we expect that range to hold," say Lloyds.
Lloyds forecast the GBP/EUR exchange rate at 1.14 at end-2018, however the pair is seen falling to 1.08 at end-2019, presumably because the ECB will at this point be engaged in an interest rate raising cycle.
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