Bank Analysts say Pound Sterling Vulnerable to More Losses against Euro

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Pound Sterling will struggle to recover value against the Euro over the coming days and the balance of risks is for further losses say some analysts we follow.

Currency researchers from Barclays, Crédit Agricole, ING and MUFG say a recent trend of decline registered by the Pound to Euro exchange rate (GBP/EUR) is linked to issues facing the economy and the Bank of England's stance on monetary policy, both of which are unlikely to reverse anytime soon.

A subdued economic outlook and the imminent end to the Bank of England interest rate hiking cycle comes at a time when the Federal Reserve and European Central Bank (ECB) are intent to hike further.

Although there have been some bright spots in UK economic data of late - PMIs show the economy likely expanded in February - economists say they have not yet seen enough to overturn expectations for an economic contraction in 2023.

"The pound also will lack much domestic direction this week with the main UK event risk looming with Friday's read of January growth. Forecasts suggest the UK economy eked out growth of around 0.1% to begin the year after it contracted by a solid 0.5% in December. The weak state of the UK economy has served as a recent rally capper for sterling," says Joe Manimbo, Senior Currency Analyst at Convera.

"We further think that FX investors will continue to see the GBP as a useful recession and stagflation hedge and doubt that the currency will recover further without the support of real UK rates and yields," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

The Bank of England is meanwhile expected to signal later in March that it has completed its interest rate hiking cycle as it expects inflation to rapidly fall back to the 2.0% target as gas prices fall and the economy slows.

The end to interest rates will be welcomed by households and businesses, but from a foreign exchange perspective, it could mean ongoing weakness for the domestic currency, particularly against the Euro.

"Benign monetary policy will weigh on the pound," says a weekly currency briefing from Barclays.

GBP/EUR was quoted at 1.1266 at the time of writing, down half a percent from where it started the week. This ensures bank transfer rates are in the region of 1.0870-1.1040, competitive cash and holiday rates at ~1.1137 and competitive payment rates at ~1.1235.

Barclays says the Pound will struggle as the "still dovish Bank of England" comes alongside "significant and persistent inflation in the UK".

This is why analysts at the bank warn their medium-term forecast for EUR/GBP to reach 0.87 risks being broken to the upside.

(EUR/GBP at 0.87 is GBP/EUR at 1.15, a level the exchange rate has already surpassed. If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.)

Above: GBP/EUR has been trending lower since 2022. (Consider setting a free FX rate alert here to better time your payment requirements.)

Barclays says risks to their GBP/EUR outlook are also a result of the recent upside surprises in Eurozone inflation, which they say will likely push the European Central Bank to raise rates faster and to a higher level than the Bank of England.

"BoE cannot match ECB hawks," says Francesco Pesole, FX Strategist at ING Bank. "The ECB’s narrative has fallen more convincingly on the hawkish side compared to the BoE's".

Data out last week from the Bank of England's Decision Makers Panel survey signalled that firms now expect to raise prices and wages at a slower pace, which favours a more cautious monetary policy approach.

ING still thinks the Bank will hike by 25bp on 23 March, but the market’s pricing for an additional 50bp of tightening after that seems too aggressive.

"EUR/GBP may continue to find support beyond the 0.8900 level for now as the euro may gain more momentum in the crosses and unstable risk sentiment should hit GBP harder," says Pesole.

(EUR/GBP at 0.89 gives a GBP/EUR of 1.1236.

Above: Market expectations for the next two Bank of England meetings.

Lee Hardman, Senior Currency Analyst at MUFG, says the Bank of England is currently the least hawkish compared to the ECB and Fed which is resulting in short-term yield spreads moving against the Pound.

At the start of February as UK rate market participants moved to price in the Bank of England's Bank Rate reaching a peak close to 5.00%.

But comments from Bank of England Governor Andrew Bailey last week saw the expected peak for the terminal rate has since nudged back closer to 4.75%.

"I would caution against suggesting either that we are done with increasing the Bank rate, or that we will inevitably need to do more," said Bailey.

MUFG now expects the Bank to deliver one more 25bps hike this month.

"We expect the ECB to stick their hawkish policy stance when they meet this month. Another larger 50bps is done deal and we expect the guidance to leave the door open to another 50bps hike in May following further upside inflation surprises in the eurozone," says Hardman.

This divergence in ECB/BoE direction has been weighing on GBP/EUR for much of 2022, and the message from these analysts is that it can continue to weigh.