"Time to Sell" Pound Sterling v Dollar and Euro say BofAML Exchange Rate Strategists

• Pound to Euro exchange rate today: 1 GBP = 1.1182 EUR, this week's best: 1.1211, low: 1.1125
• Pound to Dollar exchange rate today: 1 GBP = 1.3034 USD, this week's best: 1.3037, low: 1.2986

It’s “time to sell GBP” says Athanasios Vamvakidis, a foreign exchange strategist with Bank of America Merrill Lynch Global Research in a note to clients released ahead of the new week.

The call by Vamvakidis comes as momentum against Sterling appears to be growing once more; the UK currency recently declined to fresh eight-month lows against the Euro with GBP/EUR falling to 1.1122 in the wake of the European Central Bank’s July policy briefing.

Against the Dollar there has been a little more resillience, but even here the strength is not expected to last.

“We see bearish GBP risks mounting,” says Vamvakidis. “The second round of Brexit negotiations showed no progress”.

Last week saw the UK and EU's first phase of technical negotiations get underway in Brussels as both sides tried to make headway on issues concerning the Irish land border, the exit bill and the rights of UK and EU citizens.

The talks were largely technical in nature and no major breakthroughs were announced and the general feeling amongst traders is that a wide chasm still exists between the two sides.

The reality of the situation brings Brexit firmly back into the spotlight for Sterling, and the glare is not comfortable for the UK currency.

“Press reports suggest that the EU is not including the UK rebates in its calculation of UK budget contributions post-Brexit, which we believe would be a non-started for the UK,” adds Vamvakidis.

Domestic politics are not constructive either with the UK government apparently divided on its Brexit strategy and goals while high uncertainty about the government's sustainability in its current form continue.

We did however report a positive development on this front on Friday, July 21 when Environment Secretary Michael Gove stated that there was unity amongst cabinet colleagues on the issue of a two year transition period being put in place once the UK exits the EU in March 2019.

The stability of the exit process has long been a concern for markets, and suggestions that a unified approach to the matter is crystallising will certainly play positive for Sterling we feel.

The Dollar is potentially vulnerable to losses against the Pound, "I am bullish and expect to see range expansion to the upside, perhaps similar to the EUR/USD price action last week," says Fawad Razaqzada at Forex.com. "With this almost being the last week of July, and with GBP/USD now above this month’s opening price of 1.3010 and last month’s closing price of 1.3022, it looks like we may already have seen the wick of the monthly candlestick form."

In the past two weeks the USD index - a broad measure of Dollar value - has dropped a sizeable 1.8%, adding to the 5.1% decline in the first 27 weeks of the year to take the cumulative year-to-date downtrend of the broad dollar to 6.9%.

The drivers of this dollar weakness in the past two weeks, and generally for the past half-year are numerous, between US cyclical, rest-of-world cyclical factors, as well as a slew of Washington issues driving discount versus cyclical rate-spread models that reached fresh highs in recent weeks.

Get up to 5% more foreign exchange by using a specialist provider. Get closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.

ECB Removes Ceiling to Euro Strength

Concerning the Pound v Euro, the outlook remains firm with the analyst community looking increasingly bullish on the single-currency’s prospects.

The Euro’s broad move higher has been consistent with improving Eurozone data and could no doubt continue if the data keeps improving.

But, it is the ECB’s unwillingness to talk the Euro down which really matters.

During the press conference to the July meeting we picked up on Draghi’s answers to a question regarding the ECB’s tolerance of the Euro’s strength.

In the past the ECB has shown a nervousness about the Euro becoming too strong, lest it work against the ECB’s agenda of boosting the Eurozone economy. After all, a stronger Euro makes for more expensive European exports.

"It's true there have been movements in bond price, asset price, exchange rates and so on," noted Draghi, "but financing conditions remain supportive."

So while a "repricing of exchange rate has received some attention during various exchanges," as noted by Draghi, there appears to be little concern with the value of the Euro at this stage which might have been taken by some traders as a green light to buy.

“The pre-ECB EUR/USD level was a key threshold for the market, as this was the level at which the ECB used to intervene verbally in the past to express concerns about the strong currency and its negative implications for inflation. By avoiding such statements, Draghi has effectively removed the acceptable EUR ceiling for the ECB. Further EUR appreciation could become easier, as the ECB seems to have given up trying to "control" the currency,” says Vamvakidis.

So that’s a green light for the Euro then.

BofAML Forecasts for the Pound

Official BofAML forecasts see the GBP to EUR exchange rate to trade at 1.1494 by the end of 2017, which is actually higher than current levels which has us questioning the thrust of their recent analysis - does this mean a downgrade to the forecast target is coming?

The exchange rate is actually forecast to trade around this figure for the duration of 2018.

The GBP to USD exchange rate is forecast to trade at 1.24 by the end of 2017 where it should stay for 2018.

ING say GBP Weakness not to be Underestimated

The sentiment at BofAML is shared by strategists at ING Bank N.V who have also warned those with an interest in Pound Sterling's future direction that they should not expect an easy ride for the UK currency over coming weeks.

Analyst Viraj Patel at ING Bank’s London branch (pictured above) briefs clients that, “GBP's weakness should not be underestimated in the current $-selling backdrop.”

What he is suggesting is that the rise in GBP/USD above 1.30 might be flattering the Pound as that decline is largely a function of Dollar weakness and not Sterling strength.

Indeed, the Pound is wallowing at fresh eight-month lows against the Euro as we speak, largely thanks to a fresh bout of Euro strength following the ECB’s July policy meeting.

There are a number of reasons to believe Sterling is likely to struggle.

“The stagflation warning signs are flashing for the UK economy after this week’s data, while any ‘soft’ Brexit euphoria is slowly beginning to fade as the reality of difficult negotiations begins to sink in,” says Patel.

Patel does see some positives for Sterling in that the UK cabinet is now apparently agreed that a transitional period following the UK's exit date from the EU will be required to allow for continuity and soften any potential impact that the move might represent.

However, further details of such an agreement period must be forthcoming before Patel will get excited about Sterling's recovery potential.

Technicals: Downtrend Intact

The Pound to Euro exchange rate (GBP/EUR) remains in an extended downtrend signified by a series of lower highs and lower lows being recorded on the daily charts.

The downtrend saw the July 12 lows at 1.1170 breached last week and the exchange rate has moved down to a new low at 1.1113 established last Friday (July 21):

The last move down was steep and bearish and we see a probable continuation of the bear-trend to an eventual target at the significant round-number level of 1.1000.

Such a move, however, would require confirmation from a break below the 1.1113 lows.
The one potential spoiler is the lack of downside momentum in the MACD indicator.
Whilst the exchange rate is making new lows, the MACD is not corroborating these lows, suggesting a lack of selling pressure.

However, this is not a significant enough indication on its own to dissuade us from our central case that the exchange rate will continue to trend lower.