British Pound and Euro Forecast to Extend Recoveries: BK Asset Management
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- Pound Sterling sees sharp volatility on rumours of softening of German stance to Brexit negotiations
- Analysts optimistic on Sterling's near-term chances noting clear signs of progress in talks
- Path higher for Euro cleared by improved sentiment towards Italy
Pound Sterling is being tipped to extend recent gains by a prominent foreign exchange market commentator who says there is concrete evidence the EU and UK are slowly but surely converging on a Brexit deal.
Kathy Lien at BK Asset Management in New York tells us that buyers are cautiously returning to Sterling on signs of progress in Brexit negotiations, and she expects further gains to potentially materialise.
The call comes following another particularly volatile session for Sterling which leapt to record its biggest one-hour gain of 2018 in response to newswire reports that Britain and Germany are ready to drop key Brexit demands, potentially easing a path to a deal before the year end.
The reports indicate that both sides are prepared to forego ironing out some details on the future relationship now, in order to get a deal done.
"Germany is ready to accept a less detailed agreement on the U.K.’s future economic and trade ties with the EU in a bid to get a divorce deal done, according to people speaking on condition of anonymity because the discussions are private. The U.K. side is also willing to settle for a vaguer statement of intent on the future relationship, postponing some decisions until after Brexit day, according to an official who declined to be named," says a report on Bloomberg, who broke the news.
The report notes the question of how much detail to agree before Brexit has divided EU governments for a year, with Germany and France pushing for a detailed plan and the UK’s closest allies, such as the Netherlands, wanting to leave options open.
The Pound-to-Euro exchange rate leapt to record the current week's high at 1.1164 while the Pound-to-Dollar exchange rate hit this week's current high at 1.2982.
But, as is often the case when 'unnamed sources' are responsible for market-moving news, there will always be some scepticism.
"We’ve heard these kinds of rumours lift the pound before and it should be treated with caution. There is a strong chance that this rally could run out of steam and retrace in fairly short order," says Neil Wilson with Capital.com.
Indeed, subsequent headlines saw a Germany government official play down the rumours.
The Pound has nevertheless largely managed to hold onto its gains at the time of writing with GBP/EUR at 1.1122 and GBP/USD at 1.2930.
"The GBP experienced a choppy session, spiking to a high of 1.2983 after news that the UK and German governments had abandoned key demands in order to make it easier to strike a Brexit deal. But later gains were pared back, sending the GBP back down to 1.29, after reports that Germany’s position on Brexit is unchanged," say ANZ Research in note to clients.
Progress Nevertheless
But for other analysts there is never smoke without fire and they believe we are seeing signs of potential progress that should command a stronger Pound.
"The reason why sterling could extend its gains is because Brexit negotiations are ongoing and while the Irish border issue is a big one, between the recent comments from EU chief Brexit negotiator Barnier and today's rumour, we may be getting closer to a Brexit deal," says BK Asset Management's Lien.
Lien argues the European Union is more willing to negotiate with the UK than in the past and headlines like the one today on Germany fosters hope for a breakthrough.
"As a result, buyers are cautiously returning to Sterling and as the pair rallies, their demand will trigger more short covering," adds Lien.
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Analyst Viraj Patel with ING Bank N.V. says that from a strategic viewpoint, recent price action confirms the favourable risk-reward on Sterling lies to the upside i.e. the bigger moves are likely to come in response to good news as the currency has already absorbed a great deal of negativity.
"Who needs Brexit details! GBP showing how it is much more sensitive to good news vs. bad news. May not last (like post Barnier) but dips make GBP attractive," says Patel.
Another noted analyst agrees.
"The extent of negative sentiment, combined with undervaluation, means that the currency tends to rally sharply on more positive news headlines," said Bill Street, head of investments for EMEA at State Street Global Advisors.
Adding to the notion that Sterling has already absorbed a great deal of bad news is Peter Kinsella, Senior Currency Strategist with Commonwealth Bank of Australia, who says even if no Brexit deal is reached, the weakness suffered by Sterling won't be severe.
"In a No Deal scenario, which means the UK leaves the EU on 29 March 2019 without a transition agreement or trade deal, we anticipate GBP will decline on a trade-weighted basis. We do not anticipate severe GBP weakness because GBP already trades at very low levels in real effective exchange rate terms," says Kinsella.
Kinsella adds that "most of the worst case scenarios are partially, but not entirely, priced in."
Others however see notably deeper declines being possible on a 'no deal' Brexit.
Analysts at Bank of America Merrill Lynch warn that such a scenario would possibly unleash a barrage of Sterling sales from central banks which could push the currency down to 1.10 against the Dollar.
And looping back to the Pound-to-Euro exchange rate, a break to 1.10 in GBP/USD suggests a break below 1.0 in the GBP/EUR according to Bank of America's forecasts.
We also note that the Pound-Euro exchange rate - widely considered the best indicator of FX market sentiment towards Brexit - is caught in a decidedly negative move that is proving hard to break.
Studies show that exchange rate is trapped in a channel; additionally the pair is showing a 'stair-casing' type of pattern that looks suggests any break lower is a matter of days away.
The 'stair-casing' pattern is simply a pattern of lower highs and lower lows, a classic technical give-away of a market that is in a downtrend.
"The structural damage already done by penetrating the March (1.1150) low in recent weeks will not be easily repaired and on this basis re-emergent GBP strength is probably at best wave B corrective," says Trevor Charsley, an analyst with brokers AFEX in London.
Based on the above evidence, to us it appears that a break below the 1.0991 low is inevitable under current technical and fundamental conditions.
It will take some concrete and official good news on Brexit to snap this trend.
Looking ahead, on Thursday September 06 Brexit negotiators Michel Barnier and Dominic Raab are back at the podium to brief on the latest progress - or lack of - in this week's talks.
Euro Could Also Extend Gains
The Euro has struggled against the Dollar of late, but could also be about to turn higher against the Dollar.
"Buyers are also slowly returning to the Euro," adds Lien, even if the latest Eurozone economic reports were mixed with the downward revision to Germany's composite PMI index offset by the upward revision to the Eurozone's report.
"The reason why the euro received such a boost from the possibility of a Brexit deal is because a resolution for the UK also eases the uncertainty for German businesses working with UK companies," says Lien.
However, the main reason BK Asset Management think the Euro could extend its gains is because in the last 48 hours, we've seen a significant decline in Italian bond yields.
Having reached a high of 3.2% at the end of last month, 10 year Italian bond yields are now hovering near 2.9%.
There were concerns for Italian bonds and the Euro should conflict between between Rome and Brussels emerge had the government pushed for a budget that violates EU budget rules.
Lien argues the Italian government's reassurance that the EU's deficit rules will be respected is finally resonating amongst investors who are also relieved that Italy avoided a ratings downgrade by Fitch last week.
"Technically, EUR/USD is trading back above the 50-day SMA and if it clears 1.1650, it should be smooth sailing to 1.17," says Lien.
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