Pound to Euro Forecast: GBP/EUR at 1.1365 Next Year say Danske Bank

October 19, 2023 - Written by John Cameron

STORY LINK Pound to Euro Forecast: GBP/EUR at 1.1365 Next Year say Danske Bank

Surge in US Bond Yields and Slide in Equities Squeeze Pound Weaker, GBP/EUR Exchange Rate Hits 3-Week Lows

The Pound came under pressure on Wednesday with an important impact from the sell-off in US Treasuries and higher bond yields.

Overall risk conditions were also weaker which undermined the UK currency, especially with sharp losses in equity markets, and overall confidence in the UK outlook remained fragile.

The Pound to Dollar (GBP/USD) exchange rate briefly rallied in early Europe on Thursday before selling resumed and it dipped to 2-week lows at 1.2100 as the dollar posted net gains.

The Pound to Euro (GBP/EUR) exchange rate also retreated to 3-week lows just below 1.1500 as it tested key support in the 1.1490-1.1500 area.

The US S&P 500 index posted a 1.3% decline and the FTSE 100 index traded 1.0% lower in early trading on Thursday with weaker equities hurting the Pound.

According to ING; “FX correlations with the S&P 500 suggest the dollar will hold gains in a sell-off, largely at the expense of the commodity and activity currencies. GBP/USD actually has one of the highest positive correlations with the S&P 500.”

If US and global equities remain under pressure, the Pound will, therefore, tend to suffer.

Global influences have dominated with sharp losses in US Treasuries and higher bond yields.

There were also domestic reasons for losses in US Treasuries given fears that US rates will have to stay higher for longer.

Looking at yield spreads in isolation, Credit Agricole sees scope for near-term dollar gains based on yield spreads. It notes; “the USD is starting to look undervalued vs the EUR, GBP, CAD and JPY according to our short-term fair value models that are based on relative rate differentials among other fundamental FX drivers.”

Markets were also watching the acrimonious developments in the House of Representatives as Ohio Congressman Jordan again failed to secure sufficient votes to become speaker.

Congressional chaos reinforced fears that fiscal control would come under further threat with higher deficits.

There has been further selling of Treasuries by China and ING notes that Chinese holdings have amounted to $235bn since the beginning of 2022.

Bond selling on fiscal fears and global bond selling could hurt the dollar.

According to ING; “At some point, there is a risk that the US Treasury yield to dollar correlation briefly flips from positive to negative. We are probably not there yet, however.”

As far as Federal Reserve policy is concerned, comments from Chair Powell will be watched closely.

Rhetoric from Fed speakers on Wednesday continued to suggest that the central bank would take time to assess economic developments and hold back from raising interest rates.

According to MUFG; “The US rate market has already moved to almost fully price out another hike at the next FOMC meeting on 1st November which should limit downside for the US dollar from Fed Chair Powell’s comments today unless he more strongly indicates that they less inclined to hike rates again in the current tightening cycle.”

The latest Fed Beige Book on economic conditions reported that there was “little to no change in economic activity” in most districts and that labour market conditions had eased further.

MUFG noted that it represented a downgrade from the last Beige Book which had described economic growth as “modest”.

The bank added; “The recent disconnect between the strong hard data and softer survey data casts doubt on the sustainability of strong growth.”

The latest UK inflation data failed to provide Sterling support with little net change in expectations surrounding Bank of England (BoE) policies.

There were further concerns that sticky inflation would prevent the BoE from loosening monetary policy.

The UK 10-year bond yield also increased to an 8-week high above 4.70%.

Higher yields will put further upward pressure on debt-servicing costs and widened the budget deficit.

Danske Bank considers that debt concerns will undermine the Pound.

It noted; “The UK government would have to start making significant reductions to the deficit and bigger reductions than what might take place in the euro area before we would start to turn less negative on GBP and we have a difficult time seeing how that could happen next year with elections coming up.”

It forecasts that GBP/EUR will weaken to 1.1365 next year.

Deutsche Bank economist Sanjay Raja added that the UK economy would be “walking a fine line between recession and stagnation” in the coming months.”

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TAGS: Pound Euro Forecasts