British Pound will Rally Against the Dollar and Euro into Year-End say Lloyds

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- Pound Sterling tipped to rally as the risk of ‘no deal’ fades

- Expect the GBP/EUR range to hold

- But GBP/EUR could weaken towards 1.08 in 2019

One of the UK's most recognised high-street lenders have said they expect Pound Sterling to recover over coming weeks as the prospect of a 'no deal' Brexit fades.

The call by Lloyds Bank provides some relief to those looking for a recovery in the value of the Pound owing to the poor August the currency has endured; it has fallen against a host of rivals as markets increased their assumption for a 'no deal' Brexit to transpire in March 2019.

"It is clear that attention has shifted to the downside risks around Brexit," says the Lloyds Bank International Financial Report - the bank's flagship monthly currency analytical and forecast piece.

Increasing risks of a ‘no deal’ were recently highlighted by comments from Trade Secretary Liam Fox and Bank of England Governor Mark Carney, while Prime Minister May is reportedly ramping up preparations for a 'no deal' scenario over coming weeks.

The comments "have led to an increase in the ‘Brexit risk premium’, also translating into an uptick in implied volatility," say Lloyds.

Optimism for Recovery

However it is argued by Lloyds that markets might be a little too pessimistic on Sterling's prospects going forward.

Although there is only limited time for negotiations before the March 2019 deadline, and the situation remains fluid as political discussions intensify, Lloyds Bank's central case assumes the UK government will.conclude a withdrawal agreement by March 2019.

"We believe that optimism around such an agreement should see GBP/USD rally as the risk of ‘no deal’ fades," say Lloyds.

However, analysts say the Pound-to-Dollar exchange rate could struggle to extend gains in 2019, as the challenges and uncertainties around the future relationship with the EU take centre stage.

The GBP/USD exchange rate is forecast at 1.35 by year-end, where it should hover for much of 2019 ahead of a decline to 1.33 by year-end 2019.

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Sterling-Euro Restrained in a Range

With the Pound and Euro both softening against the US dollar, Lloyds observe GBP/EUR remains confined to a narrow medium-term range.

The range is broadly seen as lying between 1.11 on the downside and 1.15 at the top and defines the levels traded by the Pound-to-Euro exchange rate since September 2017.

"For now, we expect that range to hold," say Lloyds.

The GBP/EUR exchange rate confirmed in the previous week that the 1.11 support zone remains valid and should therefore be viewed as an area that could potentially continue offering support against any weakness going forward.

Monetary policy divergence remains one area that Lloyds see offering Sterling an advantage over its continental cousin: "the fundamentals suggest the currency pair should be a little higher."

The Bank of England unanimously voted to raise the Bank rate by 25bps at its August policy meeting and signalled further hikes.

"In contrast, at the latest ECB meeting, President Draghi presented a cautious outlook, suggesting its tightening cycle would not begin until late in the third quarter of 2019. The respective interest rate differentials should be providing more support to GBP/EUR," say Lloyds.

Yet, analysts note the market is seemingly paying little attention to fundamentals, but is instead primarily focused on Brexit-related developments.

"This is likely to remain the case until we get clearer guidance on the nature of the future relationship between the UK and EU. The outcome remains highly uncertain at this stage," say Lloyds.

Lloyds forecast the GBP/EUR exchange rate at 1.14 at end-2018, however the pair is seen falling to 1.08 at end-2019, presumably because the ECB will at this point be engaged in an interest rate raising cycle.

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