The Pound to Euro Exchange Rate in Sudden Reversal as US Dollar Slides 

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GBP/EUR has given back all the gains it made on a day which saw it surge by 1% against the Dollar and Euro at one stage.

Indeed, a strong start to the new month saw GBP/EUR breach the 1.18 resistance point and take out the round target at 1.19.

At the time of writing however we are back below 1.18! A spectacular reversal.

  • EUR/GBP today seen at 0.8472, up from a day’s low of 0.8368
  • GBP/EUR to fluctuate around 1.1798, down from a session best of 1.1949

The culprit is, we believe, the US Dollar. The US Dollar index is down by half a percent which has allowed the Euro to surge higher.

This has taken EUR/GBP alongside.

This tells us that the main game in town remains the movement of bond yields in the United States. Treasury yields are paring back and taking the Dollar alongside.

The Dollar and Pound have been tied together more or less since Trump won the November elections, and this relationship looks to be stuck fast at this stage.

“The US Dollar faltered for the first time since the US Election as the rise in US interest rates starts to raise a question about future growth. The currency market is concerned about how the US economy will cope with higher interest rates. After 8 years of ultra-low interest rates, since the financial crisis, considerable excess debt will have built up in a number of companies and households,” says a note from foreign exchange broker HiFX in Aukland.

Watch Friday’s non-farm payroll data out of the United States for direction.

David Sparks Flurry of Pound Buying

The GBP/EUR conversion was at its best level since the start of September on December 1 and those with currency transfers were looking at retail rates in the region of 1.1450-1.1750, depending on who supplies your currency.

The gains in the Pound came as the UK Government signals it is willing to pay for access to the EU’s single market.

The news was delivered in an answer by the Brexit Secretary David Davis in the House of Commons on Thursday.

During questions in the House of Commons, Labour MP Wayne David asked if the Brexit secretary would “consider making any contribution in any shape or form for access to the single market”.

Davis said the government would look at the options during the article 50 process over the next two years.

“The major criterion here is that we get the best possible access for goods and services to the European market,” he said. “And if that is included in what he is talking about, then of course we would consider it.”

Businesses and markets will welcome the move towards gaining access to the single market as it removes a major layer of uncertainty that has been hanging over the whole Brexit debate for weeks.

“Sterling is on the tear this morning on hopes for a soft Brexit,” says Neil Wilson at ETX Capital. “The Pound has reached its best level against the euro since September as the clouds of uncertainty over Italy’s referendum weighs on the single currency. We could get a further fall in the Euro if Italy votes No on Sunday.”

The gains in Sterling also come on a combination of rising UK gilt yields, a continued technical short-covering move, increased nerves over European politics and the fading of hard-Brexit fears.

But, we are warned today that this state of affairs cannot be expected to last indefinitely.

ING: The Higher Pound Rises Now, the Deeper the Fall

Sterling is expected to fade back down to a new equilbrium by strategists at ING who this week have released their forecasts for 2017.

The lower levels best encapsulate the uncertainty that is expected to characterise the political, economic and financial outlook as the UK moves through the Brexit negotiation period.

According to analysts at ING Brexit means the UK economy will undergo a structural shift which must be reflected in a lower long-run range for Pound Sterling.

“The lack of tangible details over the ‘when, what and hows’ of the UK’s future trading arrangements with Europe has meant that markets have been left to play a guessing game,” says ING’s Viraj Patel in London.

For ING, GBP price action since Brexit has been reflective of some weighted distribution of the various endgame outcomes, with the probabilities shifting as developments unfold:

ING forecasts

“We believe the broader risks to GBP continue to lie to the downside – at least until the tail-risk of a ‘messy divorce’ has been taken off the table,” says Patel.

New Risks to Consider in 2017

Patel and his team suspect the guessing game in markets may continue for a bit longer.

GBP is likely to bear the brunt of this lack of political transparency, while further uncertainty over the UK’s eventual degree of access to the EU single market could see the emergence of new unaccounted risks:
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  • Domestic political risks: Risks of an early general election to linger as UK politicians
    remain split on the optimal Brexit strategy. Calls for a second Scottish independence
    referendum would gather momentum if substantial single market access is conceded.
  • External stability risks: Ongoing uncertainty may not only see a slowdown in inward
    FDI flows, but a possible reversal of capital flows that would derail UK asset markets.

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Where other analysts have ditched calls for further Bank of England interest rate cuts and/or an extension to the quantitative easing programme, ING see things differently.

The first half of 2017 is forecast to provide a tricky backdrop for GBP as the Bank of England is likely to follow-up with a Bank rate cut to the lower bound (and an extension of QE) in response to a slowdown in the real economy.

We would imagine that a notable slowdown in economic growth will be required over the next few weeks to support this view.

With UK GDP growth at around 2.5% on an annualised basis for the third quarter we would agree with those who doubt further interest rate cuts are likely in 2016.

Nevertheless, longer-term growth is certainly up for debate.

“Uncertainty over the size of the negative long-run productivity shock (stemming from a lack of economic openness) means that we are cautious over calling for GBP upside until all the potential ‘bad news’ is in the price,” says Patel.

ING’s Forecasts for the Pound Against the Euro for 2017

EUR/GBP:

Q1 0.87
Q2 0.90
Q3 0.90
Q4 0.90

GBP/EUR:

Q1 1.1494
Q2 1.11
Q3 1.11
Q4 1.11

Source: Pound Sterling

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