Pound to Euro Rate Returns Above €1.20 as Rabobank Sees Support Against the Euro
Rabobank sees French political risks supporting Pound Sterling against the Euro, even if weaker UK growth forces markets to scale back rate-hike bets.
The Pound to Euro exchange rate was back above €1.20 on Thursday, with Exchange Rates UK’s latest published quote at €1.2008, compared with an opening rate of €1.1996.
Rabobank believes Sterling can hold its own against the Euro into the new year, even if investors reduce expectations for further Bank of England interest-rate increases.
Its argument rests partly on France, where budget disputes and uncertainty ahead of the presidential election could leave the Euro vulnerable to renewed selling.
The BoE has since delivered the quarter-point increase anticipated in Rabobank’s pre-decision note, taking Bank Rate to 4%.
That fulfils the first part of the bank’s rate call, but leaves open the question behind its currency warning: how much more tightening will follow?
A rate rise does not settle the Pound’s outlook
Rabobank ranked Sterling as the third-best-performing G10 currency both since the start of the Iran war and since the beginning of October, although the currencies ahead of it differed between those periods.
Expectations of a forceful BoE response to the energy shock have been a consistent source of support.
Writing before Thursday’s decision, the bank said:
“These forecasts have been pared back, but the market continues to forecast that the Bank is set to raise rates by around 90 bp on a one-year view.”
Rabobank’s own forecast was for a quarter-point increase in November followed by another in February, a smaller cumulative rise than the market pricing described in its note.
“Rabo’s view implies that there may be some softness in store for the pound as the market further re-prices BoE policy expectations.”
If investors come to expect a lower UK interest-rate path, the anticipated return on Sterling assets would diminish, potentially weakening demand for the currency.
The 90-basis-point figure is Rabobank’s pre-meeting assessment, rather than a measure of pricing after the announcement.
The MPC voted 8-1 for the quarter-point rise, with the remaining member favouring a larger increase, while its statement kept subsequent decisions dependent on the evidence.
That leaves inflation capable of sustaining pressure for higher rates even as growth weakens.
French borrowing concerns leave the Euro exposed
Rabobank traces the Euro’s October weakness partly to reduced expectations for ECB tightening as French borrowing costs rose relative to Germany’s.
The concern was the extra compensation investors demanded to hold French debt amid budget uncertainty, rather than a straightforward improvement in the returns available on Euro assets.
“Talk about contagion to other highly indebted Eurozone nations and fears about the high level of French bonds owned by foreign investors weighed on the EUR.”
Rabobank cautions:
“While this pressure subsequently eased, the single currency is likely to remain vulnerable on news of any further disappointments in France’s budget process.”
The bank also identifies uncertainty about the Eurosceptic policies of Marine Le Pen, whom its note describes as the presidential front runner.
These risks help explain why a less favourable UK rate outlook need not translate into equivalent weakness against the Euro.
Britain’s fiscal advantage remains conditional
UK government bonds also suffered in early October, but Rabobank argues that the absence of major surprises in the 28 October Budget subsequently helped restore support.
Rabobank writes:
“Even though it is not difficult to be sceptical as to whether the UK government will be able to achieve its fiscal targets, a plan supported by a strong parliamentary majority can be considered to be decent starting point.”
The comparison with France offers Sterling some protection, but cannot remove the domestic strain from expensive energy and borrowing costs.
Thursday’s construction report added to concerns about fourth-quarter growth, with Pantheon warning that the sector’s downturn posed a downside risk to its forecasts.
Rabobank sees the broader household outlook deteriorating too:
“After stronger than expected GDP data through H1 and into the summer, expensive energy prices, a broadening of inflationary pressures and higher interest rates at both the short and long end of the curve are likely to weigh on growth.”
“Disappointing UK data could be the catalyst for the market to rein back BoE rate hike expectations which could soften the pound.”
Against the Euro, however, Rabobank remains more confident:
“That said, the Eurozone is also facing headwinds to growth. This factor coupled with French budget frictions and uncertainty connected with the French Presidential election suggests that GBP is well place to hold its own vs. the EUR into the new year.”
Rabobank has not supplied a revised numerical exchange-rate target in this note.
Instead, it signals that its projections are under reconsideration: “We will be looking to review our EUR/GBP forecasts in the coming weeks.”
