- Reference rate GBP / EUR at publication:
- Place: 1.1772
- Bank transfers (indicative guide): 1.1460-1.1542
- Specialist money transfer rates (indicative): 1.1666-1.1713
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The pound may be in a lose-lose situation with investors seeing possible Bank of England rate hikes both favorable and unfavorable, but Credit Suisse is sticking to a bullish forecast.
Although the pound-to-euro exchange rate is near its 2021 highs, currency analysts believe it should be higher given the recent rally in UK bond yields.
UK bond yields have risen faster than their eurozone counterparts, implying that the pound is expected to be higher against the euro.
Popular explanations for an apparent GBP / EUR underperformance are that Brexit risks associated with Northern Ireland have made a comeback and the Bank of England is set to raise interest rates.
This latter explanation is curious because generally higher interest rate expectations translate into a stronger pound, so it is at odds with the moderate nature of the currency in recent times.
Money markets suggested on Wednesday afternoon that there were 100 basis points of significant increases for the UK by the end of 2022.
Such a rise in the cost of borrowing when the growth outlook is subdued could actually hamper future growth, so the Bank of England could be guilty of a policy error.
“There is no shortage of commentators, including ourselves, warning that this pace of UK rate hikes could place too great a burden on the consumer in the current environment,” said Jane Foley, senior currency strategist at Rabobank.
Above: UK ten-year government bond yields rose in anticipation of a Bank of England rate hike. Image courtesy of FT.
She says household finances are already grappling with rising energy bills, a reduction in benefits by Â£ 20 per week, an increase in national insurance contributions from next April and the end of the security provided by the recently terminated leave plan.
That leaves the pound as one hell of a currency: if the Bank cools rate hike expectations (supposedly making a policy error), the pound could be sold as investors assess recent expectations.
Shahab Jalinoos, head of currency strategy at Credit Suisse, says there is now “a popular notion in the market that the pound sterling has to go down no matter what.”
“Either because the BoE ends up being more accommodating than the market expects, or because the BoE makes early rate hikes to control inflation and ends up making a ‘policy error’ by moving closer to a weakening outlook for growth, â€explains Jalinoos.
Jalinoos recently wrote about how the potential of the British pound has been tested by the ‘permanent bears’ in the analyst and investor communities who are prone to exaggerate the problems facing the UK economy. .
For its part, Credit Suisse is inclined to maintain “a more intermediate idea that the market will somehow not know how growth will unfold for a while”.
They expect, however, that the Bank of England’s political intentions – the desire to raise rates in the face of rising inflation – will trump the pound.
“We believe this reality is ultimately what wins for the pound sterling against the euro, albeit with only modest additional gains now likely from current levels,” Jalinoos said.
Credit Suisse targets EUR / GBP at 0.8450, resulting in a GBP / EUR target of 1.1834.
It should also be noted at this point that the market’s expectation of a first hike by the European Central Bank (ECB) has grown considerably in recent days in response to soaring inflation expectations in the euro area, a development which has shaken the upside potential of the pound against the single currency.
This development is helpful in understanding why the GBP / EUR exchange rate appears to have failed to break above the key 1.18 area in recent days and may struggle to do so in the near future.
Money markets have decided to fully integrate a 10 basis point rate hike from the ECB by the end of next year, as expectations of policy tightening continue to rise in the face of the rise in the inflation.
In mid-2021, expectations for this first hike were set at 2024, suggesting substantial movement for euro rate expectations.
Eonia money market futures dated to the December 2022 ECB meeting now see a 100% chance of such a move, down from around 60% on Friday.
The probability of a rate hike in September 2022 was over 80% compared to around 50% at the end of last week.