EUR/GBP: Upward grind? - Rabobank

Jane Foley, Analyst at Rabobank suggests that the pace of the recent gains in EUR/GBP raises the question as to whether the currency pair is on course for hitting the 2009 high close to 0.98 and whether parity has become a realistic target. 

Key Quotes

“Such a significant weakening of the value of the pound would have implications for the UK inflation outlook.  Subsequently it is likely to have implications for BoE policy.”  

“The undisputed trigger for the GBP’s dive since the middle of last year is political uncertainty connected with Brexit. More recently the appearance of much weakened post-election government has also contributed to the sour tone of sterling.  While much of the pound’s weakness has been home-made, it has been amplified by this year’s broad-based rotation into the EUR.” 

“In a year when political uncertainty is at unusually high levels in both the US and in the UK, there would appear to be an unfamiliar calm in Europe.”

“For now the EUR’s fundamentals still reflect well against those in the US and the UK.  While the pull of the euro accounts for some of the upward bias in EUR/GBP, UK political uncertainty and a slowing economy are still the biggest culprits behind GBP’s hobbled position.” 

“Last morning’s release of the second estimate of UK Q2 GDP highlights a slowdown in growth in both household spending and business investment to 0.1% q/q and flat q/q respectively. The slowdown in investment was referred to by BoE Governor Carney earlier this month in his Inflation Report press conference. He commented that, due to political uncertainty, growth in investment in the UK was not as strong as it would be otherwise given the supportive influences of strong world growth and low interest rates.  He stressed the point that this could be inflationary because without investment capacity constraints could be hit sooner.  Carney’s warnings that the market is underestimating the pace at which the BoE could put up interest rates should be GBP supportive.  That said, slowing investment demand and sluggish growth are both GBP negative factors. Given the fog of uncertainty connected with almost all aspects of the Brexit process, it is difficult to expect this backdrop changing any time soon.” 

“In recent weeks there has been a plethora of different headlines related to UK proposals for the Northern Ireland border, the role of the European court of Justice and possible solutions regarding the rights of EU citizens. None of these issues, however, have been resolved.  The EU remain committed to their pledge of sorting out issues related to the UK’s departure of the system before any discussion regarding a new trade relationship are commenced.    Given that the UK’s date of departure is now only 18 months away, there is a growing sense that time is becoming very short and that the risk of a ‘cliff-edge’ Brexit are rising.  Consequently, many companies in the coming months are likely to start implementing plans that assume a hard Brexit, some of which are likely to be irreversible.”

“Our central, published forecasts for EUR/GBP have been assuming that a hard Brexit will be avoided.  However, for modelling purposes we have pencilled in a forecast of parity for EUR/GBP on a hard Brexit.  The closer March 2019 becomes without confirmation from the UK government that the economy is facing anything other than a hard Brexit, the greater the fear about a cliff edge will become.  Consequently we are revising up our EUR/GBP forecasts to 0.96 on a 12 month view and to 0.98 in 18 months.”