RBS See Pound Stronger Against Euro in 2016, But Not Against the US Dollar

Royal Bank of Scotland's Chief Economist Ross Walker has said he sees the British pound gaining on the euro and majority of major G10 currencies in 2016.

However, against the US dollar sterling is projected to ease lower.

Despite the positive views presented in an interview with Dukaskopy Bank, Walker (pictured above) does warn that the balance of risks are to the downside.

"At the current moment, our forecast for the first rate rise is for August 2016. I think the risks are that it comes later than that," says Walker, "in my opinion, most of the risks for the economy are to the downside."

Money market data shows the first interest rate rise having been consistently pushed further into the future, following the latest reports from the Bank of England.

Market pricing suggests interest rates will not rise until the second quarter of 2016 or early 2017.

"Of course, if the US Federal Reserve raises rates in December, market pricing is likely to shift at least for a short period towards pricing in a higher probability of an earlier UK rate rise. However, it seems very unlikely that the BoE will raise rates in February, and the November inflation report was certainly not the policy signal," says Walker.

Regarding Britain's economic performance in 2016 Walker says a combination of weaker macroeconomic factors plus the risks of a UK Brexit and the impact that it could have on business confidence and investment are the factors that could yet see the first BoE rate rise being delayed further.

With regards to the outlook facing the British pound, RBS forecasts for GBP/USD and EUR/GBP suggest divergent directions.

"I believe it is a more complicated issue; thus, the bigger picture is still the Dollar strength story in currency markets. We think the Sterling probably loses a little bit of ground against the Dollar," says Walker.

The RBS analyst does concede though there is some possibility that if the UK interest rates rise expectations are brought forward, that could give some temporary support to the Sterling in the short-term.

"However, we think that in general the Sterling will soften over the next year versus the US Dollar, but strengthen against most other currencies, including the Euro," says Walker.

Sterling's Decline to be Welcomed by Bank of England

The immediate focus is on Thursday’s MPC meeting; economists are looking for no change in policy (8-1 split vote upheld).

For the pound interest lies with the nature of the minutes released alongside the decision. A bearish GBP scenario would see the Bank emphasising weak inflation as a reason to stay cautious on interest rates particularly following the latest slip in oil prices.

Volatility has been ramped up in the wake of the OPEC meeting last week and this has caused sharp moves which on the balance has been to the downside.

The intraday breach of the August 2015 low at $37.75 continued to drag prices back to multi-year lows. We know the Bank tends to maintain the view that raising rates should be avoided at all costs and therefore see the perfect excuse for the Bank to maintain its warning to markets that rates will remain lower for longer.

Concerning the strength of the GBP exchange rate, expect better news, "GBP’s recent correction lower will provide less angst for policymakers, though the MPC will be cautious over softening their stance on GBP strength given the uncertainty over the exchange rate pass through effect," say ING in a currency briefing to clients.