Brexit and monetary policy on both sides of the English Channel will be key drivers of the Pound and Euro next year.
The Pound-to-Euro rate could be set for a steep fall in 2018, according to strategists at Lloyds Banking Group, who warn of considerable uncertainty that will surround the exchange rate in the year ahead.
Brexit and monetary policy on both sides of the English Channel will be key drivers of the Pound and Euro next year, with acrimony in Brexit negotiations and slow economic growth in the UK being enough to keep the Bank of England on hold. European Central Bank policy will be important too.
“Comments from Brexit Secretary David Davis and EU Chief Negotiator Michel Barnier have reinforced the challenges both sides face in coming to a comprehensive agreement,” says Gajan Mahadevan, a quantitative strategist at Lloyds Banking Group.
Fears over the path of Brexit negotiations eased in December when the European Council voted to allow EU negotiators to begin talking about trade and transition. This was after an agreement was struck covering a “divorce bill”, the safeguarding of citizens rights after the UK leaves and the Northern Irish border.
“Davis has suggested that the UK is aiming for a ‘Canada plus plus’ deal, adding that the intention through negotiations is to treat goods and services as ‘inseparable’. However, Barnier has already outlined that there will be no ‘special’ treatment for the UK financial services sector,” Mahadevan adds.
New guidelines for EU negotiators in the second phase of talks have also highlighted scope for more deadlock between the two sides during the months ahead.
Brussels wants the withdrawal commitments to be made legally binding before the UK’s exit in 2019, but to leave the bulk of trade discussions until after March 2019.
Prime Minister Theresa May and David Davis have insisted that “nothing is agreed until everything is agreed” and that the withdrawal commitments cannot be firmed up without a wider agreement.
“Some activity indicators suggest Q4 GDP growth may be slightly softer than Q3, and the health of the UK consumer is being carefully watched. With interest rate markets are not fully ‘pricing in’ a hike until Q1 2019, uncertainty shrouds the Bank rate outlook,” Mahadevan adds
The Bank of England raised interest rates by 25 basis points, to 0.50%, in November but markets are divided over how soon another hike can be expected. Interest rate markets currently suggest it will be 2019 before the BoE moves again.
Any change in this stance will either pressure or boost Sterling as bond yields and interest rate derivatives prices rise or fall in response to new developments.
“We anticipate the next hike in UK Bank rate to be in August 2018. In contrast, we see the European Central Bank (ECB) leaving interest rates unchanged next year, although it is likely to wind down its asset purchase programme,” says Mahadevan.
The European Central Bank is widely expected to wind down its quantitative easing program in 2018, which currently sees it buy €60 billion of European bonds each month in an effort to keep interest rates low and spur economic activity.
This could place upward pressure on the Euro again in 2018 although there are risks to the outlook for the common currency too, notably around the Italian election that is set to take place in the first quarter.
“Balancing all factors, we see GBP/EUR limited to a range, forecasting 1.09 for both end-2018 and end-2019,” says Mahadevan.
The fall to 1.09 in the Pound-to-Euro rate that is pencilled in by Mahadevan’s forecast implies losses of some 3.5% next year, which is broadly similar to the loss seen by the exchange rate in 2017.
“However, given the high degree of uncertainty around key drivers, there are significant risks to our profile in both directions. Unsurprisingly, this is evident in market sentiment – analysts’ forecasts for GBP/EUR range from 1.04 to 1.25, a range of just over 20%,” Mahadevan warns.
The Pound was quoted 0.04% lower at 1.1251 against the Euro during early trading Thursday.
Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.