EUR/GBP headed towards 0.90 by year-end? - Rabobank

Faced with uncertainty related to a weak government in addition to the Brexit negotiations Jane Foley, Senior FX Strategist at Rabobank suggests that they see GBP as falling vs. the EUR towards EUR/GBP 0.90 by the end of the year. 

Key Quotes

“It was always our expectation that EUR/USD would end this year at higher levels than where it started.  This was based on our expectation that Trump related US reflationary hopes would be disappointed and that Eurozone political concerns would be subdued after the French election.  That said, a month or two ago the uptrend in EUR/USD forced us to revise higher our 12 month forecast for EUR/USD which now stands at 1.17.”

“The EUR has been bolstered not just by a reduction in Eurozone political risk but by an improvement in economic data in the region that the market was not priced for at the start of the year.  While this is yet to be reflected in any meaningful rise in Eurozone core inflation data, this morning’s readings of better than expected German Lander CPI inflation data are suggestive of an improvement in the trend.  It also supports the view of several German officials who are of the view that a reduction in ECB QE is well overdue.”

“We are expecting the ECB to taper its QE programme in 2018. While we do not expect the ECB to be in any rush to hike rates, the fact that the discussion over a rate rise even exists is a marked change from the expectations regarding ECB policy at the end of last year.  The perceived improvement in Eurozone fundamentals has coincided with a deterioration in USD fundamentals relative to market expectations.  The result has been a rotation this year from the USD back into the EUR this year, which this week has been showing little signs of slowing.  An attempt by ‘ECB sources’ to recalibrate the market’s expectations regarding ECB policy failed to have any lasting impact in containing the rise in the EUR.”

“Just a few weeks ago, the UK money markets was betting on a BoE rate rise being delayed until 2019.  On the back of yesterday’s headlines from Carney, these expectations moved in as far as the first part of next year.  It is our view that in an environment of falling real wages that the Bank will delay its first rate rise of the cycle.  That said, the MPC also have an interest in limiting downside potential for GBP that could result from the current glut of domestic political uncertainty.  Consequently we expect further hawkish remarks from the MPC in the months ahead.  It is possible the incidence of such remarks may be stepped up in response to the bullish bias that is currently gripping the EUR.”

“Faced with uncertainty related to a weak government in addition to the Brexit negotiations we see GBP as falling vs. the EUR towards EUR/GBP 0.90 by the end of the year.  We would expect that GBP would have to fall harder and faster for the BoE to pull the trigger on a rate rise in the coming months.”