More Pound Sterling Upside Ahead against Euro and Dollar says Citi

- Citi says buy GBP dips around Bank of England meeting
- Says EU-UK trade deal likely, not priced by markets
- See 3-5% more GBP/USD upside

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• GBP/EUR spot: 1.1118 | GBP/USD spot: 1.3022
• GBP/EUR bank rates: 1.0908 | GBP/USD bank rates: 1.2760
• GBP/EUR specialist rates: 1.1020 | GBP/USD specialist rates: 1.2900
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A tactical shift to backing the British Pound during July appears to have paid off for strategists at Citibank, the world's largest dealer of foreign exchange.

Analysts told clients that July would see Sterling outperform as markets had proven too pessimistic on the potential for an EU-UK trade deal to be struck in 2020, and the Pound's run higher is not yet over with appreciation potential of 2-3% remaining according to Citi's forecasts.

"In July our view on GBP turned tactically bullish, noting that markets would increasingly take note of a UK-EU deal appearing likely by the end of Q3 amid and amid the cyclical global rebound that GBP would outperform vs the USD and tread water vs other high beta G10FX," says Ebrahim Rahbari, Global Head of FX Analysis, the world's largest FX dealer.

Pound Sterling entered June having endured a sharp sell-off against the Euro and Dollar over the course of the preceding three months, with foreign exchange market participants, analysts and commentators saying a key reason for the underperformance as building anxieties over the prospects of an EU-UK trade deal being struck.

Fears that the EU and UK would automatically flip to WTO trading conditions in January 2021 following the expiration of the transitional period rose following a series of negotiations that revealed progress was being blocked by a handful of seemingly intractable positions.

The Pound-to-Euro exchange rate fell from highs around 1.15 in April to a June 29 low of 1.0898 during this period while the Pound-to-Dollar exchange rate traded at 1.2258 at this point.

But what appears to have been missed by the market is that there are in fact no real 'hard' deadlines for the current round of talks and negotiators have shown a willingness to extend the negotiating period as well as adopt a flexible approach to how negotiations are constructed which allows room for progress to be made.

Last week we reported EU Chief Negotiator Michel Barnier told EU ambassadors that he was confident a trade deal would be agreed, a view that cut across his traditionally sombre assessment of the state of negotiations.

This comment appears to have resonated with markets somewhat, and the British Pound embarked on its strongest week against the Dollar, Euro and other currencies since the pre-covid market meltdown of March. The GBP/EUR rose 1.20% last week while the GBP/USD exchange rate went 2.30% higher.

"We do not feel an EU-UK deal is priced in," says Rahbari.

The intent to strike a deal is certainly there, with the EU and UK agreeing last week to another series of negotiations, the final round of which will end on October 02 in Brussels.

Therefore two months of negotiations and meetings lie ahead, which could deliver the kind of progress required to allow a final breakthrough to be achieved at a summit of EU leaders pencilled in for mid-October.

We would therefore expect this summit to be the make-or-break point for negotiations, and until then the Pound might find itself better supported if the market comes around to the view that a deal is highly likely around here as leaders on both sides of the channel will not want to be seen to fail on the matter.

Turning to short-term drivers, the key domestic risk for Sterling this week meanwhile comes in the form of the Bank of England's policy meeting on Thursday, where further guidance on interest rate policy will be released as well as the Bank's latest economic forecasts.

Markets will be looking for any indication that the Bank is looking to boost its quantitative easing programme further, or consider cutting interest rates to 0% and beyond.

Discussions about the above would likely impact Sterling valuations, with the Pound likely to be particularly prone to a warning on cutting rates further.

"We see more GBP upside and would buy any dip on a dovish BoE outcome on Thursday, where we don’t expect the BoE to put negative rates firmly on the table," says Rahbari. All eyes will be on guidance around the lower bound for Bank rate, currently at "close to, but a little above, zero".

Citi strategists "like buying GBP dips on a dovish change in guidance on the lower bound, although this is not our base case," says Rahbari.

"Net-net, we think GBPUSD can still rally another 2-3% vs the USD over the summer and even EURGBP looks set for 0.89," says Rahbari.

EUR/GBP at 0.89 gives a GBP/EUR exchange rate of 1.1240.