Pound Sterling Could Eventually Right Itself Against the Euro say Analysts

An ever-weaker Pound Sterling will merely stoke a further increase in inflation, likely reigniting speculation of a BoE rate hike being in the pipeline, which could then have a corrective effect.

Strategists at MUFG are arguing that the inflationary consequences of a further fall in the pound to euro rate could ultimately create the conditions required to allow the currency pair correct itself.

When currency's fall in value the cost of importing goods tends to rise. For nations that import more than they export, as is the case with the U.K. this places notable upward pressure on prices for consumers.

The Bank of England targets an inflation rate of 2%, and might be wary of the exchange rate moving higher should it provoke a move above target.

Higher inflation could therefore bring about renewed speculation of a Bank of England rate hike.

“While the negative Brexit sentiment could certainly take the pound lower still over the coming weeks, a continued slide in the pound NEER value assumption would start to add to the inflation overshoot,” says Derek Halpenny, European head of global markets research at MUFG.

“If the economic data was to show some improvement, then that combination would help provide support for the pound. So we remain sceptical of how much further scope there is for pound selling,” adds Halfpenny.

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ECB will Want a Softer Euro

For GBP/EUR, central bank moves will be key in determining whether a stabilisation and recovery are to transpire.

The European Central Bank will be toothless in a fight to contain the Euro, according to one strategist, but the Pound to Euro exchange rate could eventually right itself even in the face of a tight lipped ECB says another.

With policy makers including German Chancellor Angela Merkel shrugging in the face of a surging Euro, which has gained more than 7% against the pound and 13% against the dollar in 2017, some currency-watchers have questioned how long it will be before the ECB eventually attempts to talk the currency down.

With the May flash-crash excluded, the pound to euro exchange rate has fallen close to its post-financial crisis low during the current week, touching 1.0784 Tuesday and trading at 1.0854 at the start of September. Euro buyers have seen the power of Sterling fall by a minimum of 7.55% so far in 2017.

Above: Relief for Euro buyers seen in late August. Can the move extend into September?

“The ECB meeting is coming up next week and there are rising risks of verbal intervention from Mario Draghi...ECB verbal rhetoric may cause a correction but is unlikely to be enough to derail euro strength,” says George Saravelos, a foreign exchange strategist at Deutsche Bank, who writing to clients about the EUR/USD currency pair.

Saravelos says that, according to various fundamental models, the euro is not far from its fair value and so its strength can be justified. His sentiment was echoed by Chris Turner, head of foreign exchange strategy at ING Group.

“A EUR/USD break of 1.20 may cause a few headaches for the ECB, but there’s little they can do about it,” Turner wrote to clients Wednesday.

In a similar, but slightly more severe case to that of the pound to euro rate, the euro to US dollar exchange rate has risen by around 13% for the year to date and has only begun to show signs of slowing since Wednesday.

“Talking down the euro would be counteractive to any tapering plans. This is why we expect the ECB to package any tapering plans in the most dovish way possible,” says Turner.

A European Central Bank that is either unwilling or ineffective at talking down the euro could mean that the pound to euro exchange rate is vulnerable to even further falls over the coming months despite an already steep discount to its fair value.