EUR/GBP: Looking through the fog – Rabobank

Jane Foley, Senior FX Strategist at Rabobank, explains that market surveys suggest that economists’ forecasts of 2018 UK growth are clustered around the 1.2% to 1.5% area and despite the lack of real debate about the likely pace of economic expansion this year, FX surveys are indicating a distinct lack of consensus about where EUR/GBP will end the year. 

Key Quotes

“Although most forecasts in the Bloomberg poll suggest that EUR/GBP could end Q4 (close to where is started) at 0.88, there is a relatively even spread of views across a wide range, although these are mostly between 0.86 to 0.93.  Although the pace of UK growth is not a significant cause of contention amongst currency forecasters, there is a lively debate developing about BoE policy.  In addition there is a huge degree of uncertainty about developments regarding Brexit and the UK political backdrop during the course of 2018.” 

“Sterling did not have a particularly poor year in 2017.  After its plunge in 2016, it was the fourth best performing G10 currency in 2017 after the EUR, DKK and SEK.  The pound’s best month last year was September when the market began to take seriously the threat of a BoE rate hike to coincide with the November Inflation Report.  Expectations that the BoE will hike rates once more in 2018 brought additional support to the pound.  That said, the impact on GBP of a single rate hike in 2018 will be diluted by expectations that several other G10 central banks are also likely to be backing away from extremely accommodative policy conditions in 2018.”

“The UK money market is currently pricing in one more 25 bp rate hike from the BoE at the turn of the year.  If the market is by then coming to terms with a less accommodative ECB, more rate hikes from the Fed, the BoC and several other G10 central banks, the anticipated move from the BoE is unlikely to offer the pound too much additional support.  It is our view that the BoE will have to step up its hawkish rhetoric if rate-hikes are to be source of support for the pound this year.  This is possible if the Bank’s assumption that wages will rise comes into fruition.  That said, signs that UK labour market tightening may already have peaked in addition to the impact on consumption from the declining real incomes should ensure a continuation of the cautious tone from the MPC.  Currently we see little risk of another BoE rate hike before the end of 2018.  Therefore we see a softer bias for GBP vs. the EUR for which we maintain a positive view.”   

“The other factor that will be directional for the pound in 2017 is politics.  The market is currently awaiting further clarity about the shape of the post Brexit transition deal in addition to any clues about the future trade relationship between the UK and the EU.  The UK press have suggested that the PM may deliver another major speech towards the end of this month.  This could make or break the suggestion that the PM could endorse the UK devising a modified customs union – a proposal which is likely to be opposed by hard-line Brexiteers.  More likely the speech will be used to set out how the UK intends to approach the Brexit transition period and provide clarity regarding its length and purpose.”

“The EU’s guidelines published at the end of last month indicated that the transition period should not continue beyond December 31 2020 and that the UK should continue to follow EU law in this period, staying within the EU’s customs union and single market until Brexit fully commences.  However, the full terms are yet to be negotiated and PM May has suggested that the cut-off date will be among the topics to be decided.  The pound is likely to react well if an agreement about the transition period is announced before the spring.  That said, our central view is that GBP could be bias lower this year vs. the EUR on the risk that the EU/UK trade talks will prove difficult.  While we see risk of a more towards 0.95 on a 12 mth view, our expectation of a last minute trade deal supports a surge in the pound next spring.  We have pencilled in a 15 mth forecast for EUR/GBP at 0.82. Unsurprisingly, surveys are currently pointing to an even wider spread of market forecasts for EUR/GBP in 2019.”