Morgan Stanley Forecast a Pound to Euro Exchange Rate Decline to 1.11
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Strategists at Morgan Stanley have told clients that they continue to see value in selling the British Pound against both the US Dollar and Euro.
Pound Sterling will start August within familiar territory with markets unwilling to take major bets on the UK unit ahead of the all-important Bank of England policy decision due on 4th August.
There is a risk that an under-whelming response by the Bank could prompt a fresh bout of GBP strength, which we believe could take the pair back above the 1.20 barrier.
The GBP/EUR exchange rate has fallen from pre-referendum highs above 1.30 to the present 1.18-1.20 range witnessed in late July.
While downside momentum has certainly faded, it has not been abandoned.
Indeed, in all likelihood a convincing policy response from the Bank will be delivered, which should in turn devalue the British Pound as cutting rates and increasing quantitative easing devalues a currency on a unit basis.
Strategists at US investment bank Morgan Stanley agree saying a strong response is the odds-on scenario and have confirmed to clients that they see opportunity in continuing to sell the Pound against both the US Dollar and Euro.
Why Morgan Stanley are Betting on a Weaker GBP
Strategists say they remain convinced that there should be sufficient
Bank of England MPC members to vote for at least a 25bp cut at the August 4th policy meeting.
“GBP is going to be responsive to further commentary coming out of the inflation report and will weaken if the BoE is open to further easing measures such as QE or even cutting rates below the perceived lower bound of 10bp,” says a strategy note from Morgan Stanley.
Monetary policy easing in both the UK and around the world should add further downside pressure for bond yields.
“UK bond yields being higher than those in the Eurozone, means that UK
bond yields have further to fall, supporting our long EURGBP trade,” says the note.
On a macro basis, weak data is expected from the UK in coming months while the Brexit outcome is negative for euro area growth, analysts see no immediate channel that is likely to drive EUR weakening.
The euro area runs a current account surplus, which would need to be recycled elsewhere to drive EUR weakness - “a tall order in an environment of declining risk appetite and returns.”
Another factor to watch for is any positive news on the Italian bank recapitalisation should add EUR support over coming weeks.
Even if the ECB cuts rates by 10bps in September, as Morgan Stanley’s economists expect, this is unlikely to do much for EUR given the bank balance sheet constraints and the already depressed level of yields.
“The risk to this trade is the BoE disappointing markets this week,” says the strategy note.
On 14th July Morgan Stanley sought to sell the GBP/EUR exchange rate at 1.1999.
The target for the trade is 1.11, while a stop loss is placed at 1.2270, in the event of the British Pound staging a notable recovery.
Sell GBP/USD
Selling GBP/USD is an alternative, or complimentary expression that can be pursued, "for all the reasons mentioned below for the EURGBP trade," argue Morgan Stanley. "We see good risk-reward with selling GBPUSD on rallies too. The risk to this trade is that any broader USD weakness limits any downside in GBPUSD for now."
What the trade looks like: Limit Order (14-Jul-16) Enter: 1.3500; Target: 1.2500; Stop: 1.3800.
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