Analyst: GBP/EUR Exchange Rate Could Recover to 1.10

An imminent announcement for an exit from quantitative easing by the ECB could keep a lid on the Euro, benefiting the GBP/EUR exchange rate in the near-term.

The Pound to Euro exchange rate (GBP/EUR) could rise further over coming days as the market rounds on the common currency and strategists increasingly question the consensus on European Central Bank quantitative easing.

After falling close to a post-financial crisis low beneath 1.0750 at the beginning of the week, the pound to euro exchange rate pared losses to reach 1.0860 at the start of September. Conversely, the Euro to Pound exchange rate slid back to 0.9184.

A recovering Eurozone economy and expectations of an ECB tapering of its bond buying programme were behind the build up of Euro gains until late August.

Top of the pile for downward drivers towards the end of the month were concerns the ECB might attempt to talk down the exchange rate when it meets next Wednesday, September 7 out of fear it might miss its inflation target.

A strengthening exchange rate tends to push lower imported inflation, thereby making the ECB's 2% target harder to achieve.

The ECB has thus far failed to show any decisive view on the exchange rate while German Chancellor Angela Merkel has also opted to avoid criticising the currency's rise while on the campaign trail ahead of German elections.

“At the July meeting Draghi managed to sound dovish without elaborating much. With a new set of forecasts and the new market focus on FX we think the ECB will have to be more explicit,” says Bank of America Merrill Lynch economist Gilles Moec ahead of the September meeting.

“We expect a similar tone, expressing optimism regarding the domestic economy and the labour market, while acknowledging the exchange rate risk, says Holger Sandte, a strategist at Nordea, in a note to clients.

Above: The Pound's nascent recovery against the Euro looks fragile, but one analyst says a move to 1.10 is possible.

“The Euro appreciation will be a headwind to headline and core inflation in the coming years where the ECB’s inflation projection - particularly considering the longer forecast horizon - already seems optimistic,” says Pernille Bomholdt Henneberg, chief analyst at Danske Bank.

Others factors behind the correction lower in the Euro include a view that the currency had simply overshot its fundamental value and ran out of momentum.

But regardless of what may have been the instigator, there is now a consensus emerging on the Euro that could see it remain under pressure during the coming days, to the benefit of Euro buyers.

“Markets are expecting too much from the ECB.... We expect very slow QE tapering and forward guidance linking rate hikes to inflation,” says BAML fx strategist Athanasios Vamvakidis, in a separate note Thursday.

Any soft approach to tapering will arguably be more detrimental to the Euro than the use of words in impacting the value of the currency.

If strategists are right and the ECB not only sounds a dovish note at its Wednesday meeting, but also ties its eventual tapering of bond purchases to increases in inflation, then it could keep the euro under pressure for some time to come.

“EUR/GBP has reversed sharply off Tuesday’s high above 0.93, following the EUR overshoot...Brexit noise will only intensify this week, but we suspect the current correction in EUR/GBP can extend to the 0.9100 area,” says Chris Turner, head of foreign exchange strategy at ING Group.

From a GBP/EUR perspective, this gives us a potential extension to the ~1.10 area.

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