EUR/GBP: Time for a pause – Deutsche Bank

Oliver Harvey, UK Macro Strategist at Deutsche Bank points out that EUR/GBP has hit their year-end forecast of 0.91 sooner than expected, so with investors returning from the beach, they are reviewing the fundamentals. 

Key Quotes

“First, EUR/GBP is quite stretched. The 14-day RSI has hit the highest level since May's Brexit speech at the Conservative Party Conference last year and has only been more stretched four times since 2008.” 

“Second, on the data front, economic surprises are showing tentative signs of bouncing. Last week's earnings data was slightly better than expected, and the unemployment rate fell yet again below the BoE's (revised) target of equilibrium. We don't expect the Bank of England to tighten until there is more clarity about Brexit outcomes, but they are unlikely to be thrilled with recent currency weakness with GBP TWI not far off post-Brexit lows. Bank of England pricing has also gotten very dovish again with no hikes now priced until well into 2019, and EUR/GBP has already overshot short-end rates.”

“Third, on Brexit, the UK is shifting incrementally towards a more realistic view. While last week's paper on customs was not received well in Brussels, the government has proposed a more pragmatic approach to the biggest sticking point in negotiations - legal enforceability of a deal - by proposing a version of the EFTA Court. The next round of negotiations gets underway next week so the EU reaction to the proposal will be interesting.  Bigger picture, UK concessions are coming too slowly to be optimistic about agreement at the October meeting, but political noise may rise again in September, particularly with proposed cross-party amendments to water down Brexit legislation.”

“By contrast, the outlook remains weak on the flow front. The trade balance continues to show no sign of improvement, and if anything appears to be deteriorating, despite strong European growth. The UK also remains very vulnerable on the capital flows front. M&A inflows have dried up and portfolio inflows will be sensitive to ECB tapering.”

“Finally, on positioning, IMM and CORAX data suggest selling of GBP in recent weeks but shorts are still well below previous peaks, and volumes have been light. This suggests that the sterling position is short but not heavily owned.”

“To sum up, the potential for more hawkish rhetoric from the Bank of England, rising political noise in September and stretched technical indicators warrant some near-term caution, so we tactically take profit on our long EUR/GBP recommendation from the May Blueprint. Big picture, a weak flow picture and little possibility of Brexit resolution before year-end means that we remain structurally bearish on GBP.”