Pound-Euro Week Ahead Forecast: Dip Buyers Drawn at 1.1650 as 1.1760 Beckons to GBP

Modified: Monday, 02 August 2021 08:54 BST
Written by: James Skinner

- GBP/EUR bought on dips back to support at 1.1650
- Market caution possible ahead of latest BoE decision
- But institutional bids keep 1.1730, 1.1760 in prospect
- BoE's stance, 2024 CPI view key to sustainable upside

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GBP/EUR reference rates at publication:
Spot: 1.1716
Bank transfers (indicative guide): 1.1406-1.1488
Money transfer specialist rates (indicative): 1.1610-1.1634
More information on securing specialist rates, here
Set up an exchange rate alert, here

The Pound-to-Euro exchange rate has made an enthusiastic bid for the ground above 1.1730, a level which it could get the better of again this week if Sterling continues catching the eye of institutional punters, though sustainability of the move would depend on the outcome of Thursday’s Bank of England (BoE) policy decision.

Sterling has remained an outperformer of late having risen against all in the G10 contingent of major currencies except the Swiss Franc and Swedish Krona last week, with many observers citing a retreat of the coronavirus.

The coronavirus' tentative capitulation in Britain paints a picture of stark contrast between fortunes of the UK economy and those of other countries including Australia, Japan and many others mired in renewed or otherwise mounting waves of infection; not to mention resulting restrictions on business activity and social contact.

“The fall in caseloads coincided with a period of particularly warm weather, when people likely spent more time outdoors. That said, this alone is unlikely to explain such a sharp fall,” says Abbas Khan, an economist at Barclays.

The Pound-to-Euro exchange rate entered the new week around 1.17 but facing a series of technical resistance levels located between 1.1732 and 1.1760, including 78.6% Fibonacci retracement levels of April's downward correction as well as March 2020’s coronavirus-inspired collapse, both of which act as short-term impediments.

“We may see some very near term consolidation,” says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank.

Above: Pound-to-Euro exchange rate shown at daily intervals with selected moving-averages and Fibonacci retracements of April’s correction indicating possible areas of resistance.

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Jones and the Commerzbank team advocated last week that clients buy the Pound-to-Euro rate on dips back to the 1.1655 area, which coincides closely with the 50% Fibonacci retracement of a three month recovery from April’s lows just beneath 1.15, to last week’s high around 1.1765.

This is a likely site of technical support for Sterling, which is supported further down by its 55-day moving-average at 1.1647 and 100-day average at 1.1624, all of which could help to break any falls over the coming days.

On the upside, GBP/EUR would be found trading back above 1.1730 and testing 1.1760 this week if the main Sterling exchange rate makes another attempt on the 1.40 handle; and even if at the same time the main Euro exchange rate, EUR/USD, makes another attempt at reclaiming the 1.19 level that stymied it last week.

“We have been encouraged by recent positive COVID data from the UK suggesting that the risk of further pandemic related disruption to the UK economic recovery has diminished,” says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG, who advocated Friday that clients buy GBP/EUR at 1.1734.

“The policy divergence between the BoE and ECB should continue to widen as the ECB has signalled strongly it does not plan to raise rates even as the eurozone economy is recovering more strongly and inflation is set to rise above target. We expect GBP gains to accelerate against the EUR once the year to date low at 0.8472 [GBP/EUR high at 1.1803] is taken out,” Halpenny writes in a Friday note.

Above: Pound-to-Euro exchange rate shown at daily intervals with selected moving-averages and Fibonacci retracements of April recovery trend indicating possible areas of support.

Analyst teams at Commerzbank and MUFG are just two of many to have recently advocated bids for a Pound that is also now drawing interest from trading desks dealing on behalf of banks themselves, with the London FX desk at J.P. Morgan the latest as far as Pound Sterling Live can ascertain.

"The view is to buy GBP on dips ahead of 1.3900 in GBPUSD and [1.1695 in GBP/EUR] looking for a test of 1.4000 and [1.1806 in GBP/EUR]," says an unnamed trader, writing in a daily commentary emailed out to clients of the bank. "I will use weakness to accumulate GBP."

This is all ahead of the main event this week which is without doubt Thursday’s 12:00 BoE policy announcement.

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Thursday's announcement will see new forecasts for GDP growth, inflation and other economic variables unveiled in a new Monetary Policy Report, at the same time as decisions on interest rates and quantitative easing.

It will have multi-month implications for Sterling and especially if the BoE surprises the market with any decision to slow the pace of bond purchases under its quantitative easing programme from the current £3.4BN per week or to halt the programme in its entirety; though there's little if-any evidence to suggest appetite for this at the bank.

With actions and guidance for future policy aside, the most important item inside the various documents published on Thursday will be the bank’s inflation forecast for the third quarter of 2024; most notably, where it sits in relation to the BoE’s 2% target for the consumer price index inflation rate.

Above: Pound-to-Euro exchange rate shown at weekly intervals with selected moving-averages and Fibonacci retracements of 2020 collapse indicating possible areas of resistance.

Any increase in the tail-end forecast for inflation would signal a rising chance of economic conditions that could lead the BoE to raise its 0.1% Bank Rate sooner and potentially by more than markets anticipate for the coming years.

“The key data development has been indications that labour market slack is being eroded much more rapidly than previously thought – the 500k+ surge in PAYE employee numbers in May and June, which could conceivably push the CPI central projection above the 2% target during Year 3 (we look for an overshoot of ~10bp during the final year),” says Ross Walker, chief UK economist at Natwest Markets.

“We are revising our BoE Bank Rate forecast in the light of the dramatic gains in the PAYE employee data. We bring forward our forecast for the first hike, +15bp to 0.25%, to November 2022 from February 2023,” Walker writes, in a briefing last week.

Rising longer-term inflation forecasts would likely be a bullish outcome for Sterling this week while no change to the longer-term projections could potentially have a stifling impact and be discouraging to recent admirers.

“The labour market remains the biggest question mark in the MPC's outlook, and with large uncertainties remaining, we believe the Bank will be hesitant to alter its existing forecasts materially,” says Barclays’ Khan.

Above: Natwest Markets graph shows 'hawkes' and 'doves' of the BoE's Monetary Policy Committee.

“We expect that the Bank will undertake a similar update to its existing forecasts as it did in May, with some boosts to the short term (particularly for inflation), but little change to the medium term,” Khan explains.

There's uncertainty about which way the forecasts will cut and over what will be the BoE's tone given that Monetary Policy Committee (MPC) members’ have recently given the impression of there being a fine balance between those who view policy settings as appropriate for the foreseeable future, and those who think it could soon be necessary to reduce the level of support provided to the economy through interest rate and quantitative easing policies.

For readers' background, in the last set of quarterly forecasts (page 2) published in May the BoE’s rate setters anticipated that inflation would be sitting around 1.9% after having risen above the target in 2022, only to then return to target at the other end of the forecast horizon.

All projections were built on the assumption that Bank Rate would rise to 0.3% in the second quarter of 2023, before rising further to 0.6% by June 2024.

Above: Barclays’ forecasts for BoE policy decisions, historical decisions and consensus forecasts for Thursday.