Pound a Buy, Euro a Sell say S.E.B. Eyeing a Brexit Deal
Above: German Chancellor Angela Merkel this week confirmed with her Austrian counterpart that a 'no deal' Brexit must be avoided. Image © European People's Party, Reproduced under CC licensing
- Germany and Austria agree 'no deal' Brexit must be avoided
- S.E.B. say signs of progress offer upside in GBP/EUR
- But patience is required to achieve the right entry point
Sell the Euro against the British Pound in anticipation of a Brexit deal being done say strategists with S.E.B., the Scandanavian banking giant.
"The GBP is long-term undervalued against most currencies as Brexit uncertainty keeps the GBP under pressure. Negotiations about the final deal is likely to take two steps forward and one step back before a final deal is settled in November," say S.E.B. in a monthly foreign exchange strategy piece.
S.E.B. still believe there eventually will be a deal as the costs of failing are too high.
Indeed, the SEB strategy note to clients comes in the wake of weekend reports that Austria and Germany are both agreed on the need to avoid a 'hard' or 'no deal' Brexit.
According to weekend reports, Austria and Germany agree that everything possible must be done to avoid Britain leaving the European Union without a trade deal, Austrian Chancellor Sebastian Kurz said on Sunday before a meeting with Chancellor Angela Merkel.
Austria currently hold the Presidency of the Council of the European Union.
Kurz and Merkel said they were meeting to discuss a range of issues, including Britain’s planned departure from the bloc in 2019, immigration and efforts to bolster EU border security ahead of an informal summit of EU leaders in Salzburg next week.
“We have the same view that we must do all we can to avoid a hard Brexit,” Kurz said in a statement before the meeting.
The Pound-to-Euro exchange rate has staged a recovery through the course of September as markets breath a sigh of relief over signs that both the EU and UK are showing a strong desire to achieve a Withdrawal Agreement before year-end, and in the process avoid a disruptive 'no deal' Brexit.
Indeed, even hard line Brexiteers in the UK's ruling Conservative party are not seen to be advocating for a 'no deal' as being a preferred outcome; instead they are seen to be arguing for a 'Canada Plus' trade agreement under the influential European Research Group chaired by Jacob Rees-Mogg.
With the EU and UK inching towards a deal, strategists at SEB say those involved in the market should "maintain some patience and buy the GBP vs the EUR on levels above 0.90 targeting 0.86 by the end of this year."
In GBP/EUR exchange rate terms, buy Sterling weakness below 1.11, targeting a rise to 1.1630.
Above: GBP/EUR rarely spends time below 1.11. Image (C) Pound Sterling Live.
Clearly the entry point is important here - 1.11 is widely considered to be the lower-bound of the Sterling-Euro range and therefore offers more conviction to those eyeing a recovery.
The call to buy Sterling at the expense of the Euro by SEB follows a similar call made by fellow Scandie lender Nordea Markets.
We reported last week Nordea are of the belief Sterling will rise under all Brexit scenarios.
"As markets have already priced in a significant risk of “no-deal” outcome (around 40% judged from various prediction/betting markets), we expect any deal reached to be GBP positive, which is reflected in our current GBP forecast. The exact timing of the turn is, however, difficult to estimate," says Andreas Steno Larsen, an FX strategist at Nordea Markets. "Expect a bloodbath in a cliff-edge scenario. In any other case, buy GBP."
Larsen and the Nordea team anticipate the U.K. will eventually secure a Canada-style free trade agreement and not the "Chequers" proposal of Prime Minister May.
They say this has more chance of being approved by the U.K. parliament too, because it would avoid leaving the U.K. parliament subordinate to European legislators and courts, among other things.
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Forecasts for the Pound-to-Euro Rate: Higher, but the Road Won't be Smooth
As mentioned, S.E.B. see Sterling as 'a buy' against the Euro in the event that it reaches suitably attractive valuations, sub-1.11. Indeed, the message from S.E.B. is that an opportunity will likely come.
In their latest monthly foreign exchange outlook publication, S.E.B. are warning the British currency could also see some steep losses before an agreement is struck.
Because negotiators are likely to slug away until as close to the deadline as possible, it is understandable market nerves will remain elevated. There will likely be disappointment for those who believe the two sides are on a smooth path towards a deal. These disappointments might well propagate Sterling weakness.
Without an agreement on withdrawal, the U.K. will leave the EU on March 29, 2019 and default to trading with it on World Trade Organization terms in what amounts to a "no deal" outcome.
S.E.B.'s call nevertheless comes in tandem with increased optimism that negotiators will soon reach a deal on terms of the U.K.'s withdrawal from the EU. This would secure a "transition period" that leaves the U.K.'s current relationship with the EU largely unchanged until December 2020, and provide time for negotiators to thrash out details of the future relationship.
"The British currency remains long-term undervalued due to the Brexit risk premium. If a deal is concluded that can be ratified by all national parliaments, its upside potential is substantial. This is what we believe will happen," says Richard Falkenhall, a senior currency strategist at SEB.
The difference between "fair value" for Pound Sterling under a no deal scenario and under the other outcomes is "huge" and heavily influenced by the likely reaction of the Bank of England to each potential result.
This is because one currency's "fair value" in comparison to another is determined largely by things like the gap between the two relevant interest rates, differences in inflation and mismatches in economic growth rates. Expectations for all of these things will be impacted differently under each of the scenarios.
"After a weak start to the year partly related to cold weather, UK growth recovered in Q2 with GDP up by 0.4% q/q. Assuming the government reaches a trade deal with the EU, we believe the negative effects on the economy from withdrawal could be significantly reduced or at least delayed until 2021. We therefore expect growth to accelerate in coming years," Falkenhall writes.
The EU's Michel Barnier said last Tuesday that a deal could be struck by early November after already having told a U.K. parliamentary committee he is open to considering alternative "backstop" proposals for how to manage the Northern Irish border if an agreement on the future relationship is not made during the transition period.
Barnier's recent optimism has already given Sterling a fresh lease of life at the beginning of September, pushing the Pound-to-Dollar rate up from 1.29 on Friday 07 September to 1.3076 by Friday 14 September, suggesting investor angst about the trajectory of the negotiations is now easing.
"We share the view that, following its initial two rate hikes, the BOE will move extremely slowly in announcing further rate increases," says Falkenhall. "Although inflation will reach the BOE target, a tight labour market and a desire among MPC members to move away from the zero bracket will be sufficient to justify further hikes but probably not until H2 2019, when the outcome of Brexit negotiations is known."
Falkenhall does not say which kind of deal the SEB team expect Prime Minister Theresa May to secure but he does warn of the potential turbulence that could hit the U.K. currency over coming months as the negotiations approach self-imposed deadlines between October and November.
"We expect EUR/GBP to fall back to 0.86 by the end of this year. Still, we may see 0.93-0.95 before this occurs," Falkenhall concludes.
A EUR/GBP exchange rate of 0.86 translates into a Pound-to-Euro rate of 1.1627 while a EUR/GBP rate of 0.95 would see Sterling trade all the way down to 1.0526.
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Lock in Sterling's September recovery: 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
