Pound Sterling Recovers Losses against Euro and Dollar as Stock Markets Maintain their Grip on the UK Currency

- Sterling firms alongside broader market sentiment
- Investors wary of fresh global covid-19 outbreaks
- GBP to see upside limited amidst Brexit trade negotiations
- Another round of trade talks begin today

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- Spot GBP/EUR rate at time of writing: 1.1404
- Bank transfer rates (indicative): 1.1105-1.1185
- FX specialist rates (indicative): 1.1190-1.1300 >> More information

- Spot GBP/USD rate at time of writing: 1.2332
- Bank transfer rates (indicative): 1.2000-1.2080
- FX specialist rates (indicative): 1.2100-1.2220 >> More information

The British Pound is looking to stabilise on Tuesday following its dip at the start of the week which came in sympathy with a decline in global stock markets; price action that confirms that broader market sentiment remains in control of the UK currency.

Both stock markets and Sterling are looking steady on Tuesday as markets await further news and data concerning the coronavirus pandemic which has triggered the deepest and most rapid decline in economic activity since 1929, and we expect both asset classes to remain reactive to headlines concerning the pandemic over coming days.

Of concern to markets over the past 24 hours is news of a small outbreak of covid-19 in Wuhan and South Korea, while news that Germany has witnessed a sharp increase in reproduction rate of covid-19 will send a signal that rushing out of lockdown comes with risks.

"The prospect of the economy gradually returning to normal was overshadowed by new clusters of corona cases in South Korea and in the city of Wuhan – where the roots of the coronavirus lie. The reports trigger fears of a second wave and with it potentially new and even harsher quarantine measures," says Mathias Van der Jeugt, an analyst with KBC Markets in Brussels.

A shift lower in stock markets tends to trigger flows out of Sterling-based assets which in turn results in lower values against the Euro, Dollar, Yen and Franc.

"As equities decline, investors tend to ditch the Pound for safety in the greenback," says Joe Manimbo, foreign exchange analyst at Western Union.

At the time of writing on Tuesday, Asian markets are broadly flat while futures data for European and U.S. markets suggests that no major surprises are in store when those markets open. This is in turn feeding into key Sterling rates with the Pound-to-Euro exchange rate trading in familiar territory around the 1.14 level and the Pound-to-Dollar exchange rate is trading at 1.2340.

Confirming the relationship between broader global risk appetite and the Pound is the relationship between the S&P 500 index and the GBP/EUR exchange rate. If we show the two assets side-by-side on a graph we note a tight correlation:

We will therefore continue to watch developments in global equity markets to give us a steer on direction in Sterling.

The impressive rally in global stocks - that correlated with a sharp recovery in GBP/EUR and GBP/USD - appears to have faded somewhat over recent weeks, as investors are left questioning whether the bounce-back has been to aggressive and whether there is too much optimism given the scale of the economic downturn.

Consensus estimates are for a 20% decline in 2020 U.S. corporate earnings, but researchers at ING Bank are concerned that this is too optimistic.

Economist James Knightley at ING has pencilled in a 2020 U.S. GDP forecast for -7%, which is well below the consensus of -4%.

If he is right, the 2020 drop in U.S. corporate profits looks set to dwarf the US$200-230 billion rolling four quarter losses seen during the Great Financial Crisis.

The prospect for a slip in global markets as valuations fall to meet reality is a distinct possibility, and under such a scenario we would expect Sterling to come under pressure.

"In the near-term we expect another wave of risk-off in financial markets as markets are in our opinion too optimistic currently on the speed and strength of economic recovery," says Georgette Boele, Senior FX Strategist at ABN AMRO. "There is an enormous gap between the economic reality and what analysts forecast, on the one hand, and the optimism among investors for the second half of this year, on the other. This should support the U.S. Dollar as most liquid safe haven currency."

While the threat of another turn lower in markets remains a threat for now we would err on seeing any weakness as being temporary as investors continue to show an undaunted optimism.

Since mid-March - when the global market recovery commenced - any weakness in stock markets has tended to be short-lived in duration, with declines inviting fresh buying interest from investors. We therefore would expect markets - and by extension GBP/EUR and GBP/USD - to look through any weakness.

"Investors are prepared to look through the 2020 slowdown and attach more weight to the 2021 recovery. For reference, investors currently price a 20% fall in S&P 500 earnings in 2020, followed by a 25% recovery next year," says Chris Turner, Global Head of Markets at ING Bank.

Another key consideration for the Pound will be the outcome to this weeks round of trade negotiations between the EU and UK, which will commence today.

Talks between the two sides are ongoing with signs that there remain areas of significant disagreement that must be overcome if a bespoke trade deal is to be agreed by year-end, when the current transition period is due to run out.

It is believed issues surrounding the Northern Ireland protocol, divergence on rules and standards and fishing rights remain the key sticking points for negotiators and Friday's post-talks briefings could trigger moves in Sterling.

There is only one more round of talks scheduled before a July 01 deadline by which a broad agreement must be reached. It is at this point that the UK and EU must agree to an extension if more time is required to agree a deal.

For now Sterling exchange rates are suggesting the market is willing to give the two sides the benefit of the doubt, noting that agreements are only ever struck at the last minute.

However we believe that anxiety about a potential failure to reach a deal will severely limit the Pound's upside potential, therefore rallies will ultimately tend to be faded.

We also warn readers that there will be significant volatility in the Pound if the UK and EU in fact fail to reach agreement by July 01, which should ultimately see Sterling fall sharply.

"Insofar as no real progress was made on the last round of post-Brexit talks between the UK and the EU and given that the summer deadline for any request for an extension to the transition phase is looming, it is difficult to be optimistic on GBP. We would favour selling rallies in cable towards a move down to GBP/USD1.19 into the summer," says Jane Foley, FX Strategist at Rabobank.