"GBP Strength has Likely Come to an End" says Danske Bank in Latest Forecast Update

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The British Pound's gains against the Euro are now 'in the bag' according to new research from a major Scandinavian lender and investment bank.

Danske Bank's new exchange rate forecasts show Pound Sterling has likely peaked against the Euro as expectations for a more 'hawkish' European Central Bank (ECB) are likely to build from here.

"GBP strength has likely come to an end," says Mikael Milhøj, Chief Analyst, at Danske Bank.

Central banks remain crucial to the outlook for both the Euro and Pound, with investors likely to favour currencies belonging to central banks that are at the start of a hiking cycle.

"Relative rates have supported GBP vis-àvis EUR over the past six months but we do not expect the channel will support GBP much further. Markets have already priced in a lot of rate hikes and relative rates may start support EUR/GBP if ECB turns even more hawkish," says Milhøj.

The call comes following a rally in Euro exchange rates after a number of European Central Bank (ECB) policy makers pointed to the prospect of an imminent interest rate hike.

The Euro rose against the Pound, Dollar and other major currencies on Wednesday and Thursday after ECB Vice President Luis de Guindos said interest rates could rise as soon as July.

ECB Council members Wunsch, Kazaks and Nagel also indicated the prospect of an imminent hike in an apparently coordinated message delivery.

For Sterling-Euro downside pressures would build on further escalation of ECB rate hike expectations, although it remains to be seen just how committed one of the most 'dovish' central banks out there will commit to raising rates.

UK growth is meanwhile expected to moderate, which should keep the Bank of England from raising interest rates as fast and furiously as the market expects.

Indeed, all signs point to a slowdown in UK economic activity in the second quarter while growth will be challenged over the remainder of the year by surging inflation and a loss of household purchasing power.

"We expect the UK expansion will continue although at a slower pace due to high inflation eroding consumers’ purchasing power and because the easy part of the post-covid recovery is now behind us," says Milhøj.

War in Ukraine a Factor to Watch

The Ukraine war still matters, but this should remain a net negative for the Euro moreso than for the Pound.

"The hit to the UK economy from the Russian invasion and Western sanctions is slightly smaller relative to the hit to the euro area," says Milhøj.

He says a hit to global risk sentiment usually weakens Sterling but if the war turns worse and/or the West imposes tougher sanctions on Russia, we are likely to see the Euro moving somewhat lower against the Poundagain.

Considerations for the Outlook

Downside risks: "The UK runs a large current-account deficit, which makes the GBP vulnerable when capital flows fade; this keeps GBP at risk vs surplus-EUR in wake of a risk sell-off."

Upside risks: "GBP remains fundamentally undervalued... our Brexitcorrected MEVA estimate for EUR/GBP is around 0.83; PPP estimate around 0.76".

(EUR/GBP at 0.76 gives a GBP/EUR rate of 1.3158.)

Danske Bank forecast the Euro to Pound exchange rate at 0.84 over a one-month, three-month and 12 month horizon.

This gives a Pound to Euro forecast profile of ~1.19.