JPMorgan Nudge Pound to Euro Exchange Rate Forecasts Lower

• FX market quotes:
• Pound to Euro exchange rate: 1 GBP buys 1.1403 EUR on the inter-bank market
• Euro to Pound Sterling rate: 1 EUR buys 0.8770 GBP on the inter-bank market

Researchers at JP Morgan have announced they see reason to lower their previously-held forecast profile for the GBP/EUR exchange rate.

In a mid-year review, analysts at the world’s largest investment bank say their overall assessment for Pound Sterling is that it should remain largely range-bound; a view that will calm the nerves of those currency-watchers shaken by the sudden dip in Sterling following the June General Election and are worried that it might plumb new multi-year lows.

The Pound has lost 13% of its value against the Euro since the June 2016 EU referendum with a fresh move lower coming in the wake of the General Election.

JP Morgan were spot-on when they forecast the Pound to fall by about 1% should the UK elect a minority Government.

Looking ahead, they believe there is the potential for the Pound to appreciate by 1-2% over coming weeks as the prospect of a softer-Brexit becomes visible and some relief-style recovery takes shape.

However, the conviction on this view is not as high as that on the initial outcome of a minority Government being elected as there are so many moving parts to the political environment to consider.

The Outlook is Murky

Indeed, we are told by JP Morgan’s Meera Chandan that the Pound faces an uncertain path forward with forces pulling both higher and lower.

Positives include:

(i) the possibility of a more conciliatory approach from the UK towards Brexit negotiations with a more realistic appreciation of the timelines involved given the reliance of the Conservatives on DUP support and a smaller majority,

(ii) reduced UK break up risk given a slump in SNP support, and

(iii) cheap GBP valuations on some longer-term metrics. The additional 1.5% weakening in GBP in response to the election has made GBP the second cheapest currency globally on a REER basis. (REER = Real Effective Exchange Rate, it reflects Sterling’s overall valuation).

However, offsetting the positives is the prospect that political uncertainty will likely dominate in the coming days and the resulting government is fragile.

“Instability of the next government could weigh on the economy which was already exhibiting signs of softening, which in turn could also have dovish implications for the BOE,” says Chandan.

Sterling has been in focus and has been the under-performer in G10 since over the course of the last month as markets ran scared into the run up of the elections. This stance was justified by the result it would appear.

The decline does however leave Sterling looking cheap with JP Morgan's analysis suggesting it is now 5% undervalued.

"This leaves GBP at its cheapest in nearly four years but with still room to weaken further if political risk intensifies since the cheapness has been larger in the past," says Chandan.

However, the cheap valuations also suggests that if the coming weeks indicate a softer Brexit, there is room for strengthening as well.

Slowing Economic Growth

The Institute of Directors report their first poll of business leaders since Thursday’s General Election reveals a dramatic drop in business confidence and huge concern over political uncertainty, and its impact on the UK economy.

Company directors see no clear way to quickly resolve the political situation, feeling that a further election this year would have a negative impact on the UK economy.

We saw a similar fall in confidence amongst businesses following the EU referendum last year which was followed by a slowdown in overall economic activity. However, business soon picked up. Will it be the case again in 2017?

Either way, “slowing growth is more relevant for GBP since the other countries in EMEA and globally are faring much better on this front,” says Chandan.

Also liable to work against the British Pound in the near-term is the structure of the market.

Traders are no longer all engaged in the same one-directional trade against the Pound which actually saw the move lower eventually stall. For a move to extend it needs fresh entrants into the market; when everyone is already engaged in the trade this impetus dries up.

Now, JP Morgan recognise that the “shorts on GBP that were sizable a few weeks ago have largely been covered, indicating that there is room for some additional downside if economic/ political conditions deteriorate.”

These offsetting factors keep JP Morgan on the sidelines on GBP till more clarity on these offsetting factors emerges.

Weighing all of these considerations, analysts downgrade GBP forecasts for the second-half of 2017 to reflect a more range-bound view.

Their EUR/GBP target for 3Q is raised to 0.89 (from 0.86) while the 4Q target is raised to 0.88 (from 0.87).

Targets beyond are held unchanged with EUR/GBP expected to remain in a range around 0.88.

Looking at these targets from a Pound to Euro exchange rate perspective, we get: 1.1236 from 1.1628, 1.1364 from 1.1494 and 1.1364.

Significantly Stronger Euro seen in 2018 at Soc Gen

While Sterling weakness is liable to do the majority of damage to the valuation of the GBP to EUR conversion, one must not forget the Euro in all this.

And again, unfortunately for Sterling bulls, the picture here is one that hints at Euro strength going forward.

In fact we could see 'significant' strength according to analysts at Société Générale.

Expectations for a notable Euro appreciation have grown as the Eurozone economy improves and analysts expect the European Central Bank to stem their stimulus programme in response.

In their mid-year review of foreign currency markets Société Générale’s most notable call is one that sees the potential for significant appreciation in the Euro which could jump like a “Jack in the Box when the lid starts opening,” says Juckes.

Interest rate volatility fuelled by central banks exiting accommodation will be channelled towards FX. In the process, the EUR/USD skew could flip in favour of EUR calls for the first time since 2009,” notes the strategist in a note to clients.

Strength in EUR/USD will certainly drag EUR/GBP higher as they do tend to move mirror each other.

'Calls' are options which appreciate when a currency rises and so indicate a bullish outlook for EUR/USD – with a target an end of year target at 1.20 according to the strategist.

1.20 may even be a conservative estimate according to Juckes' colleague Oliver Corbier, who sees the possibility of move up to 1.30  based on, "technicals, undervaluation, EA strong capital surplus and the ECB withdrawing from QE," which are, "strong forces that may propel the euro much higher than our 2018 forecasts."