British Pound to Euro Rate's Slump Overdone say UBS Citing Massive Brexit Risks for EUR Ahead

British Pound to Euro Rate's Slump Overdone say UBS Citing Massive Brexit Risks for EUR Ahead

24 March 2016, 11:16
Vasilii Apostolidi
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Markets could be too sanguine about the risks to the euro exchange rate complex posed by a Brexit and there is a risk therefore that sterling is being chased too far into the red.

The pound has fallen notably versus the euro, from a starting point up at the 1.4325 highs of November 2015, down to the current lows at 1.26058.

The exchange rate is trending well below the levels predicted by the world's leading FX forecasters who are in agreement that GBP weakness should be due to fade.

Most of the losses are attributed to investor nerves surrounding the risks posed for the British pound by a vote to leave the EU. Despite a recent move higher in the chance of a Brexit as per the betting markets, traders and analysts alike still believe the odds of the event happening are slim.

However, investors may be misjudging the impact of Brexit on the euro suggest analysts at UBS.

According to analysts at Swiss investment bank UBS, the euro’s gains versus the pound have been undeserved because the euro is itself at almost as much of a risk from a Brexit as the pound:

“Should Britain really vote to leave the union – which is not our base case – we think the consequences would be just as negative for the rest of Europe as for Britain itself. We therefore regard the recent move in the GBPEUR as overdone, because analysts have misjudged the impact of a Brexit on the euro according to Swiss investment bank UBS.”

Negative sentiment around the referendum, “should impact not only on sterling, but also the euro.”

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The view that Brexit is as bad, if not worse, for the euro than it is for the pound was forcefully put across by Barclays in early February.

Analysts at the bank said they believe markets may misjudge the UK’s referendum on EU membership in three dimensions:

1) the breadth of its potential impact as a broader European or global risk; 
2) the likelihood of a ‘Leave’ vote, particularly the later the date of the referendum; and 
3) the likely timing of the referendum and the importance of risk events that will precede it.

“Immigration is set to be the key ‘wildcard’ driving the referendum’s likely outcome and, with procedural constraints, timing. Because immigration also is the top political issue in the rest of the EU, and a UK exit would set an unwelcome precedent, the EU referendum is at least as big a risk to EU and EMU stability as it is to the UK economy; ie, the clue is in the name,” says Marvin Barth, a foreign exchange researcher at Barclays.

Trade on the 23rd of March was significant as it provided an indication of the risk premium being “priced-in” for the EU referendum, as options with a 3 month tenor included the decision date – 23rd June – for the first time.

We note a surge in 3-month GBP volatility, and the 3-month GBPUSD risk reversal showed its strongest bias towards puts (protection against decline in GBPUSD) since the 2008-09 Financial Crisis, surpassing both the Scottish Referendum and UK General Election in terms of extremity.

ECB Bazooka expected to keep Euro down

UBS go on to argue that if anything there are more compelling reasons to expect the pound to rise versus the euro than a continuation of the current trend.

Their main reason is that the ECB’s aggressive easing programme means the euro has little scope for further appreciation as any further gains by the currency would appear out of proportion given the size of monetary policy easing which have already been put in place.

Monetary policy easing is used by central banks to increase the supply of money into the wider economy when conditions are tight; it is therefore usually negative for a currency.

“In our view, the ECB has eased monetary policy to such an extent that it should be difficult to lead to a stronger euro. Furthermore, we expect a re-pricing of UK rate hike expectations once the EU referendum has resulted in Britain's continued EU membership. “

UBS finally forecast the EUR/GBP pair to fall to 0.72 in six months, in pound to euro terms this equates to a rise to 1.3888.

“Overall, we therefore expect the EURGBP to drop over the next six months, before stabilising,” say UBS.

Interestingly DNB Markets are also forecasting a solid recovery in the GBP to 1.3888, but only towards the Autumn, so patience is required.  

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