Image © David Holt, Accessed: Flikr, Licensing Conditions: Creative Commons

The Pound to Euro exchange rate has found itself in the crosshairs of a ‘perma bear’ minority but there are reasons why this part of the punditry could be caught short at the wrong end of the market in the weeks ahead.

Pound Sterling has become the subject of increasingly bearish and widespread press coverage in recent days following a number of suggestions from within the analyst community that it could be on the cusp of a sizable leg lower against the European single currency.

But much about the emerging narrative merely reflects a reiteration of longstanding and Brexit-tainted views that have gained little traction in the market since the December 2020 end of the Brexit-transition period, which gives renewed relevance to the following October 2021 remark.

"Talk of stagflation is rife in the UK media, and GBP perma-bears, an ever-present market feature since the 2016 Brexit vote, have reemerged with confidence after spending most of 2021 until now in a subdued state," says Shahab Jalinoos, Global Head of Foreign Exchange Strategy at Credit Suisse.

Source: Google. Click image for closer inspection.

Meanwhile, the reported new or novel elements in the prosecution of Sterling are deeply couched within the doubtful idea that the UK is somehow an exception to the European economic trend toward a high inflation and low growth environment that is partly the result of Russia’s invasion of Ukraine.

There are also inadvertently-self-defeating suggestions of a ‘communication problem’ at the Bank of England in addition to claims that the BoE could struggle to keep pace with its peers as interest rates rise in order to rein in runaway inflation rates during the months ahead.

“Inflation continues to rise and reached 5.2% in May, while first-quarter GDP has been revised down. We believe the French economy is currently in recession and we are revising down our growth forecast for 2022,” said Charlotte de Montpellier, an economist at ING.

One inconvenient reality for Sterling’s detractors is that official data released on Tuesday revealed a -0.1% contraction of the French economy for the first quarter, a period in which the UK economy expanded by 1%, although that’s not the only weakness in the new or novel prosecution.

Above: Pound to Euro rate shown at daily intervals. Click image for closer inspection.

Another inconvenient reality is that if there’s anyone central bank in the Pound to Euro exchange rate equation that is being overpriced by the financial markets it could well be the European Central Bank (ECB), given the remarks from chief economist Philip Lane published on Monday.

“Normalisation has a natural focus on moving in units of 25 basis points, so increases of 25 basis points in the July and September meetings are a benchmark pace. Any discussion about other moves would have to make the case for moving more strongly than this sequence of hikes in July and September,” he said in a May 25 interview with Spain’s Cinco Dias, the record of which was published on Monday.

This is potentially a headwind for the Euro and supportive factor for the Pound overnight-index-swap market pricing was on Tuesday implying something like a 70% probability of the ECB announcing a large 0.50% interest rate rise in July and a 0.25% step in September.

All of this comes as the Pound to Euro rate sits trading at a discount to short-term economic and financial fundamental factors that led TD Securities to tip Sterling as a buy with a 1.2121 target this week, and just as developments beyond the markets also suggest scope for a corrective rebound.

Source: Westpac.

“While we are forecasting an extensive move higher in EURGBP over the quarters ahead, our tactical signals indicate that the cross is quite stretched,” says Mark McCormick, global head of FX strategy at TD Securities.

“EURGBP has now entered the fade zone, where our signals increase the risks of a correction in the next two months,” McCormick and colleague Ray Ng said.

This was just before EU members agreed to cut around 90% of oil imports from Russia by the end of the year through a sixth sanctions package that is a catalyst for a Sterling-favourable improvement in the UK and EU’s terms-of-trade spread illustrated alongside EUR/GBP in the graph included below.

The terms-of-trade (ToT) term refers to a ratio that compares export prices against import prices, making it an important metric in attempts to value currencies, which can be combined for any two different currencies and used to paint a picture of the direction in which this one influence is travelling.

Source: TD Securities. Click image for more detailed inspection.