Danske Bank upgrade their forecast target for the Pound-to-Euro exchange rate but raise their targets for the Euro against the US Dollar.

Scandinavian banking giant Danske Bank are predicting the Euro will not go as high against the Pound as had previously been expected.

“The Bank of England caught us and the market by surprise by warning of a possible forthcoming rate hike ‘over coming months’,” says Morten Helt, an analyst at Danske Bank.

The cut comes after a hawkish turn at the Bank of England, born out in the latest monetary policy statement and subsequent speeches by both Governor Carney and Gertjan Vlieghe, which has led markets to begin pricing a rate hike in November.

“We have lowered our EUR/GBP forecast as we now expect the BoE to deliver an ‘adjustment’ rate hike in November taking away the ‘emergency’ rate cut it delivered in August 2016 post the Brexit vote,” says Helt.

Danske Bank do however emphasise their belief Sterling's ambitions will be limited.

They share the view the Bank is merely taking back the ‘emergency cut’ it delivered in August last year and this is therefore not necessarily the beginning of a new hiking cycle.

Sustained gains would only be expected were the UK about to enter a tightening cycle that sees multiple interest rate rises enacted.

Market pricing implies an 80% chance of a hike in November and a second increase in November 2018.

The second hike for November 2018 is seen as being slightly hawkish in Danske Bank’s view i.e. markets are misplaced in expecting a second hike so soon.

Nevertheless, the November 2017 rate rise must be respected and it is also noted speculators are positioned short in GBP and long EUR suggesting risks are tilted to "the downside for EUR/GBP from a positioning point of view."

Helt and the Danske team see the Euro-to-Pound exchange rate falling to 0.8700 pence over a three month horizon and 0.8600 pence over a twelve month horizon, the latter having been cut from 0.8800 pence.

This gives a Pound-to-Euro exchange rate at 1.15 and 1.16 respectively.

“We now expect EUR/GBP to decline to 0.87 in 1-3M driven by slightly higher UK interest rates and GBP short covering,” says Helt. “Longer term, we expect ECB’s move towards an ‘exit’ and relative growth to counter a potential for a further decline in EUR/GBP.”

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Sterling's Advance Underpinned by Better-than-Forecast Retail Sales Data

The Pound surged Wednesday after UK retails sales were shown rising at a much faster pace than was expected by economists in August.

However, the gains were soon largely reversed as markets eye other notable events on the calendar - particularly a speech to be delivered by Theresa May in Florence on Friday.

The easing back from post-retail sales highs also suggests the currency market has fully absorbed the November interest rate rise; only suggestions that further rate rises in 2018 are likely to trigger sustainably higher levels in Sterling we believe.

Nevertheless, the data is what is required to keep the near-term positive impulse seen across the Sterling strip alive.

Retail sales rose by 1.0% when compared with the previous month, according to the latest Office for National Statistics data, up sharply from the 0.3% pace of growth seen in July and better than the consensus forecast of economists for 0.2% growth.

Both volumes and sales are up:

The increase was broad-based with both non-food stores and non-store (online) retailing seeing an increase, helping to push the annual pace of retail sales growth to 2.4%, far ahead of expectations for a 1.1% expansion.

Sterling rising on retail sales numbers pic.twitter.com/6mYxsTaEgK

— Neil Wilson (@neilwilson_etx) September 20, 2017“Today’s retail sales figures indicate that consumers are showing an impressive resilience in the face of the ongoing real pay squeeze,” says Ruth Gregory, UK Economist with Capital Economics.

But Gregory warns we shouldn’t get too carried away by these figures as the retail sales figures are very volatile on a month-by-month basis.

“And high-street spending growth has been on a clear downward trend, with the annual rate of sales volumes at 2.2% in the three months to August – considerably lower than the 5-6% rates seen towards the end of 2016.”

Nevertheless, the outlook remains robust.

"It seems that consumers may have finally begun to adjust to the post-referendum price shock, and are starting to get back to more normal levels of spending," says Paul Farge, a strategist with TD Securities in London.

EUR/USD Could go as High as 1.30

Regarding the headline Euro-to-Dollar rate, Danske predict will likely remain close to its current level, in the region of 1.1970, over the coming months according to the latest forecast book from Danske.

On balance, further strength is however more likely than sustained weakness.

“While the latest uptick in EUR/USD has not been shadowed by relative interest rates, unhedged equity and speculative flows appear to have played a key role,” says Christin Tuxin, chief analyst with Danske Bank. “While these flows may be fading near term and a softly priced Fed could provide USD support, we maintain that any dips in EUR/USD should be shallow and short lived.”

For the year to date, the Euro has risen by more than 14% against the greenback and is up 7.5% in the last three months alone. Key drivers of price action have been Dollar weakness and expectations of a gradual move from the ECB to exit its stimulus program.

“While a first 10bp hike from the ECB is priced in a bit early at present (around New Year 2018/19) we stress that what is key for the FX market is the direction in which the ECB is now Headed,” says Tuxen.

Danske have upped their 12M forecast for the cross to 1.25 (1.22).

Near-term, they see EUR/USD trading around the 1.20 level and have upped their 3M and 6M forecasts to 1.19 (1.17) and 1.22 (1.18), respectively, "as the ECB now seems less vocal on EUR strength than expected."

EUR/USD is seen at 1.19 in 1M.

However, a rate rise to 1.30 is not out of the question: