Euro to Pound Exchange Rate to Fall to 0.7400 Post-Referendum

EUR/GBP may remain steady in April due to seasonal effects, however, Brexit inspired volatility could push up the pair above 0.80 in the run up to the referendum.

The UK public will vote to stay in the EU and the pound will rise back to 0.7400 to the euro in the weeks that follow, according to analysts John Shin and Michael Widmer of Bank of America Merrill Lynch.

“In our view, Brexit risks are exaggerated on the basis of previous UK voting patterns. We therefore believe that GBP will stage a meaningful recovery following the Referendum and this is reflected in our revised FX forecasts. We look for GBP to recover by the end of Q2 2016 with EUR/GBP falling to 0.74 (-5% from current levels).”

Further, they expect April trading to be subdued due to positive seasonal trends counter-balancing any further sterling-negative risk premia inputs.

There will be a delayed reaction after April when marginal opinion polls and the approaching of the referendum date will once again inspire increased volatility in GBP pairs:

“We believe that this will merely delay what we see as renewed pressure on the pound heading into the Referendum. With headline polling still suggesting a close contest, we believe that investors will view the event with a great deal of trepidation. FX volatility is therefore set to remain elevated at the front end of the curve as we approach June 23rd.”

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Economic Data Ignored

The shadow of Brexit is so pervasive it has clouded the effect of economic data, which has seen positive momentum in recent months:

“This is not being reflected in the UK rates market which remain reluctant to recalibrate their view on the timing of the first UK rate hike until the event risk of the Referendum is out of the way.”

The lack of movement in market rates – which tend to represent investors’ inflation expectations - means it is not clear when markets expect the Bank of England (BOE) to increase base interest rates.

Currencies tend to rise with interest rates. This is because foreign investors tend to prefer countries with higher interest rates as places to invest their money, as they get a better return. This obviously increases demand for that country’s currency.

Markets have been put on hold until the referendum, however, once it is over there is likely to be a sudden, swift, revaluation:

“The growing divergence between GBP and UK rate differentials versus its G10 counterparts is presenting a trading opportunity but only when the event risk has passed.”

ING see more Brexit fear pushing EUR/GBP up to 0.80 pre-referendum

ING focus more on the run-up to the referendum than BofAML. Using the comparison with the Scottish Referendum and past General Elections they argue that these events saw comparatively more volatility before the voting than the EU referendum, even though the EU referendum could have an arguably greater influence on the pound: 

“Looking back at how much risk was priced into GBP ahead of the 2014 Scottish referendum, and then the 2015 UK general election, we feel that a larger risk premium is required in GBP crosses now. The firming of Brexit risks should keep EUR/GBP above 0.80.”

They see 0.82 as the upper threshold going into the referendum as Brexit risks may start to weigh on the euro, due to fears of the referendum sparking copy-cat referenda amongst other members. This will cap Euro gains, say ING, limiting upside to 0.82.