Pound Most at Risk v Euro, Could Stay Bouyant v Struggling US Dollar say UniCredit

Modified: Saturday, 05 August 2017 12:18 BST

FX Quotes:
Pound to Euro exchange rate: 1 GBP = 1.1069 EUR
Pound to Dollar exchange rate: 1 GBP = 1.3145 USD

UniCredit Bank have confirmed they believe Sterling’s recent bout of weakness is fully justified and confirms their long-standing view that the Pound has further to fall.

However, weakness is more likely to come against the Euro and other majors as opposed to against the US Dollar which they believe still has a few quarters of weakness ahead of it.

Sterling came under pressure on Thursday, August 4 with GBP/USD falling below 1.3120 and EUR/GBP rallying above 0.90 which represents its best level for the 2017.

For UniCredit’s team, the falls are justified with their long-held view that the market had misinterpreted Carney’s message in Sintra where he said interest rate rises might be necessary were investment activity seen to be picking up and wage growth firming.

Markets appear to have simply latched onto the fact that Carney was even considering raising interest rates; the view was reinforced by the hawkish overtures made by other fellow central bankers at the same event which suggested perhaps the BoE was keen not to get left behind by the pack.

But, Carney stuck to his word regarding the importance of data.

UniCredit argue further that “investors should be bracing for a further slowdown in the UK economy as the consumer is feeling the squeeze of real income and – importantly – business intentions are unlikely to improve in the face of political and economic uncertainty”.

In this respect, UniCredit believe the market reaction that pushed UK yields and Sterling lower was the correct one.

They anticipate further currency weakness.

However, this weakness will not be uniform.

“This may not manifest itself too strongly against the USD – where it is likely that cable will stay close to the 1.30 level,” say UniCredit arguing the “weak dollar story” will remain a multi-quarter theme.

Rather, “it is against the EUR, where fundamentals (economic and political divergence) and technicals (momentum) are nicely aligning for further EUR/GBP upside,” say analysts.

However we do notice that GBP/USD might have peaked as it is clear that much of Sterling's advance is linked to the declines in the US Dollar through the course of 2017.

As such, we should actually be watching the Dollar's fortunes and the strength in the Dollar seen following the August US jobs data hints that perhaps the Greenback's declines are due to end.

This could place downside pressure on GBP/USD.

“Sterling is the most vulnerable to a deep correction as there was nothing positive in the most recent Bank of England Quarterly Inflation report and monetary policy announcement,” says Kathy Lien, Director at BK Asset Management in New York.

“Given how much GBP/USD rose in the last 4 months (from 1.24 to 1.3250), the tone of the central bank and the healthy U.S. non-farm payrolls report means 1.3270 is most likely the top in GBP/USD,“ adds Lien.

Is the fall in value of Sterling impacting your international payments? Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.

Pound Sterling's Fallout Justified

ING Bank and Morgan Stanley are two other big institutional names to come out following the Bank of England's August policy event to warn Sterling faces further weakness.

Viraj Patel, an analyst with ING Bank in London says the declines look justified to him, and he expects the GBP/EUR to now occupy the ground below their year-end 2017 forecast at 1.11.

With regards to GBP/USD, ING say they expect the exchange rate to break below 1.30 before long.

Morgan Stanley's Hans Redeker has said his team are turning bearish on the British Pound having been positive on the currency over recent months.

"We believe it is time to turn GBP bearish. This autumn may see Tory intra-party tensions culminating with the October party conference. Event risks have turned us into GBP bears,” says Redeker.

Broadbent's Supportive Message

Downside in Sterling does however appear to be tampered to some extent by the message from the Bank that 2018 might see more than one interest rate rise.

The message was hammered home by the Bank's Deputy Ben Broadbent who told the BBC there was a "trade off between stabilising inflation and keeping the economy going".

But he said the UK was "a little bit" better placed to cope with an interest rate rise.

Broadbent said the Bank's Monetary Policy Committee (MPC) believed there would need to be more rate rises than those expected by the financial markets.

"The MPC said given the other assumptions in its forecast it thought probably there would need to be rate rises, and indeed more rate rises than those priced into the interest rate curve in future than the financial markets expect. "I do think the time is likely to come when rates will go up generally."

Could there be a chance that this view is given more of an airing by FX markets? If so then we would suggest the downside in GBP might be protected going forward.

But again, it all ultimately comes down to Brexit.

Ireland’s Varadkar Suggested Free Trade Deal an Option, Hints to Positive Shift in Brexit Debate

The UK could enter into a “deep” free trade agreement with the EU if Britain leaves the single-market on Brexit argues Ireland’s prime minister in one of the more constructive developments coming out of the Brexit debate of late.

Leo Varadkar proposed that Britain and Ireland could have a transition period during which the UK negotiated a new trade deal with Europe.

Varadkar stressed that there was still “common ground” between the Dublin government, London and Northern Irish parties on the issue of the post-Brexit border.

Speaking at Queen’s University Belfast, Varadkar said: “For example if the United Kingdom does not want to stay in the customs union, perhaps there can be a EU-UK customs union. After all, we have one with Turkey. Surely we can have one with the United Kingdom?”

“If the UK does not want to stay in the single market, perhaps it could enter into a deep free trade agreement with the EU and rejoin Efta, of which it was a member prior to accession. And if this cannot be agreed now, then perhaps we have a transition period during which the UK stays in the single market and customs union while things are worked out.”

The intervention by Ireland's PM is significant in that it is certainly the most constructive take on Brexit to come out of Europe for some time.

The message from Brussels is that the UK must abide by their positions, but for Ireland, the stakes are too high to countenance such a hardline approach which might see trade barriers erected with their largest export market.

Ireland needs a frictionless trading relationship with the EU - the question now is whether they are able to carry the influence in Europe to ensure a pragmatice approach to negotiations is adopted.

If this is the case, we view it as being very positive for Sterling indeed.