Analysts expect EUR/GBP to climb towards 0.87 as crowded BoE hike pricing and UK Budget risks threaten Pound Sterling.
The Euro to Pound (EUR/GBP) exchange rate edged lower on Monday, but Rabobank analysts expect the pair to rise towards 0.87 over the next three months.
EUR/GBP traded near 0.8589 at the time of writing, down 0.04% on the day and roughly 1.3% below Rabobank’s forecast.
Pound Sterling gained limited support from Chancellor Healey’s first major address, which focused on faster economic growth and adherence to the UK fiscal rules.
The absence of detail over how new investment would be funded prevented a stronger Pound response.
Rabobank’s target would be equivalent to a Pound to Euro rate near 1.1495, compared with approximately 1.1645 at current levels.
BoE rate expectations create a risk for Sterling
Interest-rate markets have almost fully priced two 25-basis-point Bank of England rate increases over the next six months.
Rabobank considers that pricing too aggressive.
“It is RaboResearch’s central view that the BoE will leave rates on hold for the rest of the year.”
Three Monetary Policy Committee members voted for an immediate rate increase at the July 30 meeting, a more hawkish split than markets had expected. Higher oil prices have also increased the threat of renewed inflation pressure.
Governor Bailey has previously placed greater emphasis on weaker labour-market conditions and the prospect that disinflation will continue. Recent employment surveys, however, suggest that the jobs market may be stabilising.
The gap between market pricing and Rabobank’s forecast leaves Sterling vulnerable if the September 17 BoE decision fails to meet elevated expectations.
“Indeed, implied market rates indicate that two 25 bps rate rises are almost fully priced on a 6-month view. This positioning may leave the pound vulnerable.”
A rate increase is not required for Sterling to gain. Firm guidance on future tightening could preserve the current yield support.
The risk is that policymakers sound more cautious than investors expect.
“A hawkish takeaway from the BoE meeting next week is already priced in, meaning that the pound could slip on anything that can be construed as dovish.”
UK Budget uncertainty adds to Pound risk
Healey attempted to reassure bond investors by discussing fiscal sustainability, discipline and his commitment to the rules inherited from former Chancellor Reeves.
He also referred to the market turmoil surrounding former Prime Minister Truss’s mini-Budget, signalling that the government understands the danger of losing investor confidence.
The unanswered question concerns funding.
Healey promised measures intended to lift economic growth but gave no indication of how they would be financed.
He acknowledged the cost pressures facing households and companies while criticising the austerity policies associated with former Prime Minister Cameron.
Specific tax and spending decisions were deferred until the October 28 Budget.
“As we have pointed out before, the gilts market has the potential to be particularly sensitive to negative budget related news because of the relatively high amount of foreign ownership.”
Overseas investors hold a comparatively large share of UK government debt.
Rabobank argues that they may react quickly when confidence in domestic policy weakens, allowing gilt-market stress to spill into the Pound.
France offers a contrast. Investors concerned about French fiscal policy can switch from French government bonds into debt issued elsewhere in the Eurozone without leaving the single currency.
Pound Sterling has no equivalent protection when foreign investors reduce their exposure to gilts.
EUR/GBP opened near 0.8592 and briefly reached 0.8595 before falling to 0.8584. The pair subsequently recovered to 0.8589, leaving it in the lower half of its intraday range.
The muted reaction to Healey’s speech suggests that markets are waiting for policy details rather than responding to general assurances on growth and fiscal discipline.
Rabobank’s forecast rests on two possible sources of British Pound weakness.
The first is a BoE meeting that falls short of hawkish market pricing. The second is renewed pressure on gilts as the Budget approaches.
“On the back of this factor, coupled with the pound’s potential sensitivity to fiscal matters, we expect EUR/GBP to be biased higher, towards 0.87 on a 3-month view.”
The September 17 BoE decision will test the interest-rate side of that forecast first. Attention will then turn to whether the October 28 Budget can fund the government’s growth plans without unsettling overseas gilt investors.
