UniCredit: GBP/EUR Exchange Rate Forecast to Fall to 1.11, GBP/USD Below Plaza Accord Levels
The Global Chief Economist at UniCredit has set out potential targets for the GBP into EUR conversion following the UK's decision to quit the European Union.
UniCredit's Chief Economist, Erik Nielsen, says notwithstanding significant intraday swings, sterling is set for a period of enormous downside pressure.
UniCredit, headquartered in Milan, have estimated that portfolio flow reversal would send EUR-GBP to 0.90 and result in sustained GBP-USD weakness to between 1.25 and 1.30.
A euro to pound sterling exchange rate at 0.90 equates to a pound to euro exchange rate at 1.11.
He further adds that his already quite bearish forecasts for the pound may be overly conservative:
“In fact, we regard these as conservative estimates given the acceleration of short bets in the pound, potential easing by the BoE, an upcoming UK recession and some (at least partial) reversal of FDI.
"As a result, EUR-GBP rising towards 0.95 and GBP-USD dropping to 1.20 or below (i.e. a level not seen before the Plaza Accord in 1985) are certainly within the realm of possibility.”
The economist goes on to paint a gloomy picture of the future for the UK economy, with the extent of the fallout dependent on the level of uncertainty over coming months:
“Uncertainty is bad for business: a sharp fall in UK risky asset prices, delays to investment, disruption to trade, and a loss of business and consumer confidence mean the UK economy is more likely than not to enter a technical recession within two years. We will now slash our UK 2017 GDP forecast to around zero (from 2.1%).”
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However, we note here that the assumption that the UK will fall into recession is debatable.
One potentially offsetting factor will be the response of UK politicians to the news. If they can reduce uncertainty then that may reduce the downside potential for the economy:
“The extent of the upheaval now crucially depends on political developments over the next few months. There are many sources of uncertainty: who will be the next Conservative leader and, hence, prime minister?
"Will the electorate accept an unelected PM? Can the Conservative Party avoid a split? How Eurosceptic will the new government be (the UK’s exit status depends critically on this)? Will the UK seek to limit free movement before a withdrawal agreement is made? Will there be another referendum on Scottish independence, and maybe even one for Northern Ireland?”
Brexit’s impact will spread far and wide, but it will particularly affect the Eurozone, and Nielsen revises down his growth forecasts for the Eurozone to 0.5% -1.0% in 2017, from the previous 1.6% forecast. The slow-down would impact all the countries in the Eurozone big and small:
“The 2017 growth forecast in Germany would drop to 0.4-0.9% from 1.4%, in France to 0.4-0.9% from 1.3%, in Italy to 0.2-0.7% from 1.2%, and in Spain to 1.3-1.8% from 2.4% (numbers for Germany are not working day adjusted).”
Despite the slowdown, Nielsen does not expect the European Central Bank (ECB) to cut deposit interest rates any lower (they are already at -0.4%) as this would probably cause more damaged to the already fragile banking system, but there is a possibility they may make more types of debt eligible for purchase in their QE programme, such as senior financial bonds, for example.
Even countries further afield, such as the US could see growth fall by between 0.25-0.50% in 2017, due to the impact on global markets.
Capital Economic’s see growth at relatively high 1.5% in 2017
His analysis runs contrasts with a more optimistic forecast from Capital Economics, who suggest growth would not shrink to zero in 2017 but merely slow down by half a percent to 1.5%.
Much of their argument relies on the weak pound doing much of the ‘heavy-lifting’ work of growth by making UK exports more attractive.
In a recent note they also see the robust response by the authorities as a major factor in their brighter outlook.
Nevertheless they agree the Nielsen basic thrust that uncertainty is likely to weigh on economic growth for several years to come.
Stronger US Dollar Ahead, Bad News for Global Economy
The safe-haven US dollar has, understandably been a winner of late.
With Britain voting to exit the European Union, downside risks have increased for the global economy.
Related uncertainties alone will restrain economic activity worldwide and force the major central banks to maintain accommodative monetary policies.
"As such, the threat of a Federal Reserve tightening in 2016 has disappeared. Still, the U.S. dollar should find support via its safe-haven properties," says Stéfane Marion at NBF Economics.
NBF see a stronger greenback as bad news for global equities as we anticipate a tightening of financial conditions.
Emerging countries are particularly vulnerable because of the sizable portion of USD-denominated debt outstanding. Also, we now see downside for commodity prices in the coming weeks (WTI down to $40).
In light of the political/economic uncertainty created by Brexit, NBF have advised clients they are altering our asset allocation by moving to a more defensive stance.
Cash is raised from 5% to 10% at the expense of equities.
"We do not anticipate a global recession as we expect central banks to gain some traction in supporting investor confidence in the coming weeks. Still, we feel that the current environment is prone to heightened volatility and justifies a reduction of risk in the portfolio. More details to come in our upcoming Monthly Equity Monitor," says Marion.
Brexit: Latest Developments
Headlines concerning the UK's vote to leave the European Union over the weekend include:
Central bank leaders have committed to work together in order to counter any ructions caused by Brexit. This could offer sterling and stocks the opportunity to stabilise.
The UK's Liberal Democrats have said they will fight the next election on a platform to return the UK to Europe.
If Labour were to do the same, then surely the UK is in for years of political division with the question of Europe promising to never die.
Meanwhile the Labour party is itself in turmoil with leader Corbyn sacking a prominent shadow front bencher, while other front benchers are seen resigning.
A busy week ahead!
