Analysts: Pound to be Supported in the Near-Term, "Grossly Overbought" Euro to Remain Vulnerable

Above: Theresa May takes control of the political narrative at the start of 2017 by rejigging her cabinet, providing a benign environment for the Pound to trade within. Image (C) Pound Sterling Live. 

Pound Sterling should remain firm against an overbought Euro over coming days abut gains should ultiamtely remain limited as traders eye the next phase of Brexit talks.

Sterling could cling to its recent gains against Euro through the immediate future thanks to seemingly benign Brexit new-flow and an economy that seems to have gathered momentum again.

However, those hoping for a sustained rally in Sterling will likely have to wait until later in the year as the clouds surrounding Brexit lift further.

At the present time Sterling appears to be finding decent support as political focus has turned from the European question to domestic politics where Theresa May has taken control of the narrative by reshuffling her cabinet.

A steady drip-feed of news concerning the reshuffle from Number 10 provided a benign environment for the politically-charged Sterling to trade within. The process has not been altogether smooth for May with the resignation of Justine Greening forming an unexpected highlight, but the ever-excitable media classes do tend to inflate issues, particularly when the news cycle is as empty as it currently is.

The key takeaway from a currency perspective is that May's position is looking secure, and the Pound likes the certainty this implies and the message we are getting from strategists concerning the immediate for the Pound is that it should endure recent ranges against both the Dollar and Euro.

"Despite the Cabinet reshuffle occurring uneventfully, our view remains unchanged and the still heavy short-term implied valuations may keep the GBP/USD trapped within 1.3500-1.3615 in the near term," says analyst Emmanuel Ng at OCBC in Singapore.

“Any GBP/USD pullback towards 1.3400/50 should be seen as a buying opportunity given our 1.40 1Q18 target. EUR/GBP to stay within the narrow 0.88-0.89 range,” writes Viraj Patel, a strategist at ING Group.

The 0.88-0.89 pence range for EUR/GBP converts to a 1.1235 - 1.1360 range for the Pound-to-Euro rate.

The Euro is meanwhile this week's worst-performing major currency as traders appear content to book profit on its recent strong run. 

"The Euro was grossly overbought with CME positioning showing a new long swing in specs to over 100K – a level at which Euro tended to correct in the past. The depth of the correction remains to be seen," says Boris Schlossberg, Director at BK Asset Management in New York.

"The correction of the Euro is mostly due to technical reasons, also considering that last week speculative long Euro (net) positions grew to a new long-term high," says Asmara Jamaleh, an Economist with Intesa Sanpaolo in Italy having also identified issues of positioning being behind the Euro's present bout of weakness.

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Brexit Nerves Could Come Back to Hurt Sterling in Quarter 1

Yet while downside to the Pound appears protected, gains will be hard to come by.

"We anticipate GBP/USD will struggle to appreciate in the short-term, reflecting the beginning of phase two of Brexit negotiations," says Elias Haddad, a currency analyst with Commonwealth Bank Australia.

As we move deeper into the first quarter of 2017, expect nerves towards Sterling to grow.  

“Given the extent of recent moves, we believe the Pound is likely to remain volatile, with the risks biased to the downside over the near-term as the negotiations continue,” says Adam Chester, head of economics at Lloyds Commercial Banking, a part of Lloyds Banking Group.

2017 saw the Pound-to-Euro exchange rate surge back from beneath the 1.10 level, to trade briefly at 1.1501 during December, as markets responded to “sufficient progress” in the Brexit negotiations.

Prime Minister Theresa May struck a deal with European negotiators over key sticking points around EU citizens rights in the UK after Brexit, the avoidance of physical infrastructure at the Northern Irish border and a “divorce bill”.

December’s deal allows both sides to begin discussing the topics of future trade and transition as soon as this month. For the Pound, progress in this next phase of negotiations is important.  

May’s government is pushing for an agreement on transition early this year, to be followed by the outline of an agreement on trade later in 2018, in the hope that the proposed deal can be approved by the European Council at its October summit and ratified in all parliaments across the EU by the end of March 2019.

“These deadlines continue to look very tight, particularly as unanimous agreement is needed among other EU members. The prospects are also not helped by the precarious position of the UK’s minority government,” says Chester.

The tight deadline, numerous signatories to a final agreement and the last minute nature of all progress, small progress at that, made to date could all mean that downside risks for the Pound intensify later in the first half of the year.

“Overall, we expect the pound to slip over the next six months, but recover a little over the second half to end the year at $1.33 and €1.09,” warns Chester.

Not everybody shares Chester’s apparently downbeat view of the Pound. Others see a smoother path for the currency throughout the first half of the year that could be followed by renewed volatility at a later date.

“Even though the British parliament is returning from its December recess so that Brexit is likely to increasingly become an issue again over the coming days, in the end the scramble about the start of the second phase of the Brexit negotiations confirmed that the talks will only see a breakthrough when a deadline is approaching and ultimatums are presented,” says Esther Reichelt, an analyst at Commerzbank.

Reichelt flags the “implied 3 month volatility” of Pound-to-Dollar and Euro-to-Pound options, noting that market implied projections for volatility in the Pound over the coming months are at their lowest level since the Brexit vote of June 2016.

This suggests that traders are content to hold Sterling for the foreseeable future without protection against wild price swings.

“As little is likely to move on the Brexit front for now and a further Bank of England rate hike is unlikely to be an issue over the coming months due to the rather weak economic outlook, GBP exchange rates are also largely determined by external factors,” Reichelt adds.

The Commerzbank team forecasts that the EUR/GBP pair will trade around 0.88 pence come the end of December 2018, which puts the Pound-to-Euro rate at 1.1360, slightly above its Monday close at 1.1329.

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