Pound to Fall Against Euro, Stay Stable Against US Dollar Argue ABN Amro

The British Pound is seen falling against both the Euro and US Dollar as we move through the opening stages of the new month ensuring the negative trend that characterised the final days of February remains intact.

US Dollar bulls are meanwhile back in control with the Greenback trading higher against all of the major currencies.

But, this could well be the Dollar's final hurrah as the multi-year uptrend is due to fade in 2017 allowing Pound Sterling to stabilise. 

In a major update to their foreign exchange forecasts, Dutch multi-national bank ABN AMRO have told clients they are now forecasting GBP/USD consolidation around recent levels to be a favoured scenario for 2017.

Analyst Georgette Boele however warns Pound Sterling could expect further losses against the Euro which is likely to enjoy a strong relief run as political risks in the Eurozone fade through the course of the year.

“We no longer expect Sterling to weaken versus the US Dollar but for it to consolidate around 1.25. This partly reflects the change in our US Dollar view. Moreover, we think that most of the hard Brexit expectations are already reflected in the price,” says Boele in a client note dated February 27.

Boele and her team therefore join a camp of institutional analysts who favour a slight strengthening in Sterling over coming months with Lloyds Bank being another prominent proponent of such a view.

As noted here, Lloyds Bank see GBP/USD heading above 1.30 over coming months.

Morgan Stanley are also in the bullish camp arguing that the Brexit story has become stale and the Pound therefore has the chance to recover some lost ground.

The Pound’s Weakness Against the Dollar is Ultimately Done

So what is driving the view at ABN AMRO?

In the period November 2015 to July 2016, Sterling had a strong negative relationship with its country default swap or CDS. A CDS - Credit Default Swap - is the cost of protecting against debt defaulting and is a good indication of how markets are pricing risks associated with the UK and ultimately its currency.

“When the CDS rose, Sterling fell versus the Euro. Despite Brexit, the CDS spread has stabilised and so did the sell-off in Sterling. Furthermore, sterling is undervalued especially versus the US Dollar,” says Boele.

AMN AMRO are not the first to point out that Sterling is undervalued according to a number of popular gauges.

SEB Markets have recently confirmed they believe the currency to be notably undervalued yet they believe this is by no means a reason to bet on an imminent long-term recovery arguing more weakness lies in store.

However, for ABN AMRO the undervaluation could be a reason to back a recovery.

“According to purchasing power parity, fair value of GBP/USD is at 1.45 and EUR/GBP is at 0.83,” says Boele.

End of the Dollar Bull Run

The Dollar heads higher on March 1 thanks to a sudden increase in market bets that the US Federal Reserve is likely to raise interest rates in their March policy meeting.

However on November 23, 2016 ABN AMRO released their FX outlook for 2017 and 2018 with a core conviction view  that the US Dollar would experience a last leg up because of stronger-than-expected US economic growth and more rate hikes than anticipated by financial markets.

Since then analysts have determined that the behaviour of the US Dollar has been disappointing as it failed to profit strongly from positive US related developments such as stronger US data releases and more hawkish comments from Fed officials.

"This signals that most of the positive news is already reflected in the price," says Boele. "Investors have changed their focus from the Trump policies that are positive for the economy (Good Trump) to those that may have an adverse effect (Bad Trump)"

Recent rhetoric from the new US Administration that currencies such as the Chinese yuan, Japanese Yen and the Euro are undervalued and that the US Dollar is too strong has weighed on the greenback.

"Moreover, if the US dollar were to rally strongly, the Fed could signal fewer rate hikes ahead, which is dollar negative," says Boele. "We think that the US dollar has already peaked. There could be waves of positive US dollar sentiment but we think it is unlikely that we will see another strong US dollar rally from here."

But Expect The Pound to Fall Against the Euro

Interestingly however, ABN AMRO do expect sterling to weaken versus the Euro further out.

“Our new year-end forecast 2017 and 2018 forecasts are 0.88 and 0.89 respectively. Political uncertainty in the Eurozone has weighed on the Euro versus Sterling of late," says Boele. 

From a Pound to Euro perspective, 0.88 = 1.1364 and 0.89 = 1.1235.

The Euro's recent underperformance comes as markets show nerves on the prospect of Marine Le Pen winning the French presidency.

Indeed, one analyst warns that such an outcome would recommend another Lehman moment for the global financial system, referencing the fall of Lehman Brothers in 2008 which was seen as being the firing of the starting gun on the great financial crisis.

But, “if political uncertainty in the eurozone diminishes, this should support the Euro. Moreover, financial markets are currently pricing in one rate hike by the BoE in our forecast horizon. We don’t expect the BoE to hike interest rates this year or next year,” says Boele.

So if ABN AMRO’s view is correct, this should weigh on the Pound, especially if ECB tapering expectations start to build from Q4 2017 onwards.

Euro Strength Ahead as Economic Confidence Returns

The ECB’s Monetary developments in the Euro Area for January showed that growth in bank lending in the Eurozone continues to rise gradually, a positive sign that suggests Eurozone businesses are starting to invest with more confidence.

The monthly flow in loans (adjusted for sales and securitisation) to non-financial companies increased to EUR 12bn from EUR 10bn, while the annual growth rate of these loans stabilised at 2.3% (a year ago it stood at 1%).

Meanwhile the flow in adjusted loans to households increased to EUR 19bn from EUR 9bn, while its annual growth rate increased to 2.2% from 2.0% (January 2016: 1.4%).

Changes in growth in eurozone bank lending tend to follow changes in nominal GDP growth with a delay of around 1.5 to 2 years.

"As such, the recent rise in bank lending growth reflects the economic recovery of 2014 and 2015. Looking forward, we expect lending growth to stabilise at levels close to the current rate in the coming quarters following the stabilisation of nominal growth as from the middle of 2015 onwards," says ABN AMRO's Aline Schuiling.