- Pound Sterling and Euro fall back into grip of multi-month range

- Recent strength in the Pound proves to be a false break

- Others maintain the view GBP/EUR is going higher

Unicredit Tower A, Milan © Sergio Fabio Brivio, Flickr, reproduced under CC licensing

The British Pound is at risk of falling back into a long-held sideways trending range against the Euro we are told.

The strategy implications for those watching the value of the British Pound of this week's disappointing data releases are profound according to an analysis of recent events which suggests the currency's recent good run might be over.

Analysts at UniCredit Bank, one of Europe's largest lenders, believe the Pound-to-Euro exchange rate could well be on course to slip back into a long-held range that has frustrated buyers of Euros and Pounds alike.

The disappointing inflation data released mid-week has caused a sell-off in Sterling as markets are seen repricing Bank of England interest rate expectations for the remainder of the year.

"At the moment, a second rate hike by the BoE is almost fully priced in on a 1Y horizon. We have highlighted before that we see this as too hawkish since we expect inflation to decline faster than the BoE currently expects. (The inflation) number has reinforced this view," says Kathrin Goretzki, a FX Strategist with UniCredit Bank in London.

Markets have been bidding Sterling higher over the course of 2018 having decided that Brexit risks have faded somewhat, the economy remains robust and the Bank of England is at the start of an interest rate raising cycle.

The Pound had achieved its best rate against the US Dollar since the Brexit vote at 1.4354, but declined all the way back to 1.4222 following the release of UK wage data on Tuesday, April 18 and inflation data mid-week.

The Euro-to-Pound exchange rate rebounded to around 0.8710 (1.1480 in Pound-to-Euro terms) having traded towards 11-month lows at the start of the week.

UK interest rates are on the move too, with the short-dated two-year UK gilt yields dropping by 5bp.

The data suggests to Goretzki and the UniCredit team that while a May interest rate rise is highly likely, some dissent amongst Monetary Policy Members "could lead markets to reconsider their expectations for the coming months."

It is what happens to expectation for the next interest rate rises beyond May that really matter; it would appear that markets are now expecting fewer, or are expecting longer gaps between interest rate rises and this is being expressed via a sell-off in the Pound.

"Combined with our expectation of a higher EUR/USD over the coming months, this implies upside risks for EUR/GBP back towards the sideways range seen since end-September 2017," says Goretski.

In short, the Pound-to-Euro exchange rate is seen sliding back into that zone that lies between 1.15 and 1.11, something the exchange rate was unable to shake for months.

If UniCredit are right, those looking to buy Euros using Sterling might just have missed the best opportunity to transact at in months.

With regards to the GBP/USD outlook, UniCredit expect a weaker Dollar, and this "still leaves some upside potential towards 1.45 by mid-2018."

Advertisement

Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here.

Don't Panic, Sterling is Still Going Higher

Analyst Viraj Patel with ING Bank N.V. in London says the Pound's move lower in the wake of the inflation data is a "knee-jerk reaction" and that the weakness should be short-lived.

The "focus on the outlook for the labour market, global growth and Brexit are all still positive," says the analyst.

He expects the GBP/USD exchange rate to drift back into the 1.42-43 range but says the risk of the Pound-to-Euro rate breaching 1.1630 "have been shelved for now".

Soft UK inflation data will sow seeds of doubt over a May Bank of England rate hike. But growth-inflation trade-off still favours *gradual* policy normalisation (textbook monpol). Will take some steam out of $GBP rally as it lowers the bar for two 2018 hikes (too early to tell) pic.twitter.com/LK31uxja4d

— Viraj Patel (@VPatelFX) April 18, 2018The fundamental landscape for Sterling has changed for the better, according to Kit Juckes, macro strategist at Société Générale, one of the City's more noted names in foreign exchange analysis, who has recently flagged the potential for further gains in the Pound.

According to Juckes, investors can now expect a combination of faster-than-expected economic growth, less political disturbance - particularly around Brexit - and a Bank of England (BOE) more willing to raise interest rates, after a decade in which they have been abnormally low.

The end result is a seductive mix which is likely to enhance the outlook for the Pound against the Euro, particularly in shorter time frames.

"Progress has been smoother than expected, because the UK has capitulated on most of the demands of the Hard Brexit rebels. There are still hurdles to overcome but a smooth exit from the EU have improved which would be supportive for growth and point to more monetary policy tightening than is currently expected," notes Juckes in a recent client note.

In addition to these reasons, the Pound is especially weak by long-term standards.

"Sterling is still trading over 10% below its 25-year average in trade-weighted terms," says Juckes, the inference being that it could drift back up over time.

"The correlation between EUR/GBP and relative rates is reasonable and there is room for UK rate expectations to rise by 25-50bp relative to European ones as growth forecasts are tweaked. A 20bp rise in UK real yields vs. Bunds, or a 25-50 re-price to further-out rate expectations, could take EUR/GBP below 0.85," says Juckes.

Advertisement

Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here.