Pound to Euro Exchange Rate Still Forecast to Reach 1.25 but Barclays Warn of a Short-Term Rebound

Pound to Euro Exchange Rate Still Forecast to Reach 1.25 but Barclays Warn of a Short-Term Rebound

29 February 2016, 12:06
Vasilii Apostolidi
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The British pound could see a reverse in fortunes over coming days in the wake of relentless selling pressure, however we and many others in the market expect any strength to be short-lived in nature and an ultimate target in the mid-1.20's to be reached.

The GBP has taken some serious beatings lately and is now over 6% lower than where it opened 2016. This is after the +-6% declines seen in the November-December period. 

There are four main reasons for the negative developments in the sterling-euro exchange rate, all of which are interconnected; deteriorating global risk sentiment, weaker UK data, postponement of BoE rate hikes and Brexit fears.

Our forecasts made at the start of February warned for a move towards 1.25, and moves through February have confirmed us to be more or less correct as the GBP to EUR conversion is now quoted at 1.2690. There is therefore still some way to go by our calculations.

As we move towards the new month there are however signs that the pace of decline in GBP/EUR could be about to ease up.

"GBP depreciated significantly last week as perceived risks of an EU exit increased. We maintain our view that the agreement was a positive development, EU exit risk has negative implications for the EUR," say Barclays in a foreign exchange forecast note released ahead of the new month.

Barclays expect the GBP to EUR pair to correct higher as a result.

Barclays confirm some reversal in recent GBP weakness against the USD is also possible this week given their above-consensus forecasts for the major UK data events out this week.

February PMI data will form the focus of the data calendar this week, if they beat expectations sterling will certainly find some love. 

Watch Manufacturing PMI on Tuesday; (consensus forecast: 52.3), Construction PMI on Wednesday; (consensus forecast: 55.5) and Services PMI on Thursday; (consensus forecast: 55.0).

Technical Support Combines With Brexit-Boredom to Lift Tone on Sterling

We note here that a mighty level of support is coming into play in the form of the 200 week moving average which could well see the decline hesitate.

This is the average price the pound has traded against the euro at over the past 200 weeks and traders often tend to reverse direction when faced with such formidable levels.

Beyond the technicals we note that the Brexit story is becoming tired.

“Further significant Brexit-fuelled FX weakness is unlikely. UK poll are notoriously inaccurate while the illusionary supportive “facts” supporting in-or-out will quickly get discounted by the opposition. Therefore neither side will make a strong advance,” says a note from the Swissquote FX Strategy Desk.

Analyst Magne Østnor at DNB Markets says there is now a good chance that the pound sterling to euro exchange rate recovers to the 1.3698 area as the recent sell-off in GBP is exaggerated and a result of several potential risk factors materialising at the same time.

“We expect to see a (bumpy) improvement of the global risk sentiment, the start of Cameron Bremaincampaign reducing Brexit risk and interest rate expectations to rise. At the other side of the English channel, we expect Draghi to act on his guiding of further stimulus, keeping the EUR under pressure,” says Østnor.

Nevertheless, it is worth remembering that trend momentum is firmly pitted against sterling at this juncture, and for that reason strength is likely to be short-lived.  

We mention that Swissquote believe further Brexit-fuelled losses in the GBP are likely to subside for now, however, this is no reason to become pound-bulls.

“We would short any GBP rallies as downside is attractive as Brexit risk premia remains despite extreme short GBP positioning,” say analysts at Swissquote Bank.

Kit Juckes at Societe Generale agrees that calling the bottom in the pound’s trajectory would be futile, and foolish:

“Between now and the vote, we’’ll see GBP/USD closer to 1.30 and EUR/GBP above 0.80. There’s too much uncertainty for bargain-hunters to buy the pound.”

EUR/GBP at 0.80 equates to 1.25 in GBP to EUR terms, and aligns itself nicely with our early Feb forecasts for 1.25.

Euro Exchange Rates to Take Centre Stage in March

The euro is looking to end February from a position of weakness having been hurt by mounting worries about a Brexit which add fuel to a growing fire of anti-EU sentiment across the 28-member bloc.

Data showed that German CPI for February surprisingly fell to -0.2%(y/y), confounding expectations for a reading of 0.0%(y/y).

The surprising negative print for CPI in the bloc’s largest economy was accompanied by news that CPI in France and Spain fell to -0.1% and -0.9%(y/y) respectively this month.

“All of this bodes poorly for the broader euro zone CPI figures due out next week, and fuels expectations that the ECB will have to act aggressively to counter mounting deflationary pressures when it meets on March 10th,” says a foreign exchange briefing from Commonwealth FX.

The ECB’s 10th of March meeting is a ‘live’ one in that policy decisions are set to be announced.

The stage is set for action at the ECB and we do not expect the euro to benefit in a major way over coming days as traders will be wary of exposing themselves to a currency that could be about to be battered by its central bank.

Assuming the UK and the pound fall out of the limelight in the month ahead, the euro is the currency to watch over coming weeks.

The Euro Today: Inflation Data, German Retail Sales

Euro area flash HICP inflation will be in focus today and we expect it to decline back to deflation territory due mainly to the lower oil price.

Despite the increase in the oil price since mid-January this year, it is still much lower than in February 2015, thereby giving a yearly drag from  energy to inflation. The oil price has historically explained around 50% of the monthly variation in inflation.

German retail sales for January were released early this morning and blew expectations by increasing at 0.7%, well ahead of forecasts for 0.2%.

The strong reading comes thanks to "the lower oil price and continued progress in the labour market as well as still-high consumer confidence," say Danske Markets. 

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