Hunting for the Best Pound Exchange Rate? Beware - GBP Forecast Lower vs Euro and Dollar by Bank of America Merrill Lynch

For those watching the British pound (GBP) we note the currency is likely to be pressured in the short-term against the euro however it is ultimately forecast to gain in the longer-term according to a new analysis from Bank of America Merrill Lynch.

However, BofA do warn that losses against a strengthening US dollar are likely to continue hurting the GBP/USD, and the best rates of 2014 may be behind us.

However, at the time of writing we note the GBP is enjoying something of a mid-week renaisance:

• The pound to euro exchange rate (GBP/EUR) is trading 0.28 pct higher at 1.2579.
• The pound to dollar exchange rate (GBP/USD) is 0.16 pct higher at 1.6812.

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Pound forecast higher vs euro longer term, short-term pressures to persist

The euro has advanced against the British pound through the course of late July/early August as markets correct to more sustainable levels.

The EUR/GBP was looking oversold following a deep Spring/Summer decline in the euro which saw market’s positioned excessively short on the currency.

In such scenarios corrections become inevitable as any pullbacks in the exchange rate tend to snowball as traders are forced to bail out as their stop-losses are triggered.

"EUR/GBP position could also suggest short-term upside risks in this cross, but we will be selling any rallies," says Nick Bate at Bank of America Merrill Lynch Global Research.

Bate does however see room for further downward correction in GBP/USD.

"We have been flagging downside GBP/USD risks in recent reports and the correction has now started. Although UK data remains strong, the consensus has become too bullish and data surprises have now turned negative. The CFTC data suggests that long GBP is the most stretched G10 FX position," says Bate.

Furthermore BofA Liquid Cross Border Flows report notes that hedge funds have started reducing their GBP long positions.

"GBP/USD looks strong compared to what historical correlations with data would suggest and could weaken further if US data improves. Moreover, our quant analysishas now turned bullish USD," says Bate.

Concerning the euro to pound exchange rate Bate is prone to favour sterling longer term:

"We remain bearish EUR/GBP, but also see some upside short-term risks as the market may be too short at this point. However, we will see such a correction as an opportunity to sell the rally. We expect normalization of monetary policies to be bearish for EUR/GBP in the longer term, as the ECB and the BoE move in opposite directions.

Euro Will See Strength if Geo-Political Tensions Ease

The euro has come under pressure recently as tensions in Eastern Europe fester and sanctions are heaped on Russia.

However, when tensions in this theatre ease the euro benefits.

The Russian Defense Ministry announced that military drills near the Ukraine border are over, "catching many traders by surprise because earlier this week Russia banned food imports from the European Union and there were reports that troops were mobilizing near the Ukraine border raising concerns that Russia would attempt another intervention into Ukraine," notes Kathy Lien at BK Asset Management.

According to Lien it appears that the outlook has improved significantly to many investors.  The euro bounced off the 1.3350 level for the third time in a row.  

"Higher highs and higher lows point to a potential bottom but given the dovishness of the ECB, continued disappointments in Eurozone data and a recession in Italy, it is hard to be bullish euros," says Lien.