Pound Sterling Forecasts vs. Dollar, Euro Lifted at Lloyds Bank

- Large upgrade to GBP/USD projections

- But GBP/EUR to be hampered by ECB interest rate rise in 2019

- Bank of England to raise interest rates in May on robust economic performance

© Gary Howes, Pound Sterling Live

The Pound has moved back above 1.13 against the Euro ahead of the weekend, while a gradual recovery against the US Dollar also appears to be intact with GBP/USD seen at 1.3940.

The gains in Sterling come just days before a key European Union meeting that will determine whether the UK and EU will enter a two year transitional Brexit period starting in March 2019, something that economists at Lloyds Bank tell their commercial banking clients is necessary in order for the Pound to firm up over coming months.

The high-street lender have announced to clients they are upgrading their forecasts for the British Pound on the assumption that Brexit risks are fading, while the UK economy continues to perform to a level that should allow the Bank of England to raise interest rates in May.

In their March International Financial Outlook publication analysts advise that their forecast targets for GBP/USD have been raised notably, but analysts caution the Pound-to-Euro exchange rate will likely tread water over the near-term as the sideways-orientated trend in place for six months extends.

However, year-end forecasts for this pair are also revised higher, albeit by a smidgen.

Driving the increased optimism in the UK currency is the assumption that the Bank of England will deliver an interest rate rise in May, something that had previously not been assumed.

"We have brought forward our forecast for the next UK interest rate rise to May, with a quarter-point increase to 0.75%. We also anticipate a further rise to 1% in November, but have maintained one hike next year," say Lloyds.

The basis for the interest rate rise lies with the UK economy performing better than economists had previously expected. The observation comes in the same week that Chancellor Philip Hammond announced the Office for Budget Responsibility had upgraded their forecasts for both growth and productivity.

The OBR also expects wages to continue growing which will in turn put pressure on the Bank of England to raise interest rates which in turn supports Sterling. "The relative resilience of the UK economy which, combined with capacity constraints, means that inflation is forecast to stay above target for an extended period," say Lloyds.

Tying into the improved sentiment towards the UK economy is the belief that the risks of a 'no-deal' Brexit outcome have receded. The publication of Lloyds' IFO report comes just a week before the EU Council meets to decide whether or not to 'OK' a Brexit transitional deal.

"Brexit negotiations remain a key uncertainty, although markets seem to perceive a lower risk of a disorderly ‘no deal’ scenario since the EU-UK December agreement," say Lloyds.

Many analysts have said the Pound's near-term prospects hinge on the delivery of such a decision in March; expect a lower currency if a transitional deal does not materialise. However, reports this week have suggested a deal is likely, and hence the support Sterling has enjoyed.

Yet while Sterling has certainly been supported, it's hardly 'flying off the shelves' in the global currency market place as traders do acknowledge risks remain with some Brexit officials on both sides saying there exists a complete stalemate on Irish border arrangements which risks derailing any agreement.

“This whole thing could end in tears,” one senior diplomat told Reuters. “British business might get a terrible shock.”

Asked by the same reporter about those concerns, a British government source conceded that there was still “a lot left to do”. The final verdict is delivered at the European Council summit on March 22-23, expect some big moves in Sterling as the decision is made clear.

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But the Euro Should be Supported

With regards to the Euro, Lloyds make another interesting assumption change -  in that they bring forward the date they expect the ECB to raise interest rates - a development that should keep Euro supported

"Our view of the ECB remains that it will continue with monthly asset purchases of €30bn until September and wind down the programme by the end of the year. That would pave the way for interest rates to be raised in the middle of 2019. We expect the main refinancing rate to be at 0.25% by end-2019, compared with 0.10% previously," say Lloyds.

The ECB has over recent months confirmed it is stepping away from its easing bias that has kept the Euro under pressure for a number of years.

Lloyds believe the Bank is preparing for an exit to bond buying by year-end, paving the way for higher interest rates in 2019.

Lloyds Bank Exchange Rate Forecasts: March Update

Lloyds Bank have revised up their target for GBP/USD to 1.38 from 1.33 at end-2018 and to 1.42 from 1.38 at end-2019.

The June 2018 forecast is revised higher from 1.35 to 1.36; the exchange rate is currently quoted at 1.3953.

As can be seen in the above, there is the prospect of further near-term weakness to come, in line with the trend of a strengthening US Dollar through February-March.

Lloyds Bank have maintained the view that the US Federal Reserve will deliver three interest rate increases this year, taking the basic rate set by the Fed up to 2.25%.

Compare this with the UK's 0.50% interest rate and you can see where investor flows will go in order to pick up a return; this should ultimately ensure the Dollar retains some element of support.

EUR/USD has also been revised up to 1.25 from 1.22 at end-2018 and to 1.30 from 1.27 at end-2019.

This upgrade to both the Pound and Euro against the Dollar leaves the Pound-to-Euro exchange rate - which is a cross of the two - as remaining static.

The GBP/EUR forecast for year-end is revised higher from 1.09 to 1.10 and the exchange rate is forecast to remain here through 2019.

The June 2018 forecast remains at 1.12, which is more or less in line with current levels suggesting more sideways action over coming months.

This suggests the high-street lender remains broadly bearish on Sterling against the Euro, considering the exchange rate is currently at 1.13.

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