Pound Sterling to Euro Foreign Currency Exchange Rate Forecast – Sterling surges against distressed Euro

Currency

By Jon Beddell

Foreign Currency Market Update – GBP / EUR Update

Pound Sterling to Euro Foreign Currency Exchange Rate Forecast - Sterling surges against distressed Euro

After falling to the lowest level in 15 months on July 1st Sterling has staged an impressive rebound, surging by over 4 cents from the recent lows that saw the 1.10 level tested for the first time since March 2010. Last week started along the same theme as the previous Friday, with Sterling taking advantage of a broadly weaker Euro. We added a cent on Monday, and another on Tuesday, spending the remainder of the week consolidating the gains. Economic data cannot be said to have been the major driver. True, retail sales contracted less than expected in June, but were still down by 0.6% on the month. Tuesday’s release of inflation figures should have sent the Pound lower, but did not. Retail prices were up a less than forecast 5.0% year on year, with consumer prices up 4.2% versus 4.5% expected. Traders initially sold Sterling, but then bought it back up by the close of business.

For the Euro’s part the week was characterised by various nations’ sovereign debt being downgraded. Even news of a smaller than expected trade deficit and an uptick in inflation did not offset the constant debt chatter. Investors have now pretty much factored in the worst case scenario for Greece, so it wasn’t a big surprise when credit ratings agency Fitch downgraded their debt to CCC, pretty much the bottom rung of the ladder, just above default. Anything below BBB is considered “junk”, meaning that investment carries “substantial risks with little prospect for recovery” according to widely used grading methodology. Ratings agency Moody’s also downgraded Irish debt to junk status last week in a move the EU Commission described as “incomprehensible”. Portugal is now graded as BBB-, the same rating as Iceland and India. Italy is also under the microscope, on review for possible downgrade from Aa2 status, which is seen as “high grade”. Although this is a long way from Greek/Portuguese levels, the concern is that Italy is too large a member of the Euro zone to be allowed to fail. Even the US is not immune to credit risks, as demonstrated by the fact that Moody’s placed their usually solid AAA rating on review last week.

The results of European bank stress tests were released after markets closed on Friday. Only 8 of the 91 European banks tested failed outright, but the markets were unimpressed by the fact that the scenarios tested did not include a Greek default, a scenario that is priced as a near certainty in the market for credit default swaps (insurance contracts to protect against the prospect of default). All four of the British banks tested passed, but it must be noted that only four banks were tested in the UK, compared to 24 for Spain.

There are various economic data due for release during the week ahead, but the markets’ main focus will be on the EU summit on Thursday, at which the main items for discussion will be the financial stability of the Euro zone, and more specifically, Greece.

The technical outlook is mixed. The gyrations of recent months look set to continue, and it would be hard to call Sterling’s rally a significant breakout until we capture the 1.16 level convincingly. In the meantime it looks like a good time for Euro buyers to take some risk off the table by hedging at least half of any currency required.

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