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2019

Sterling | Euro Quarterly Forecast

Published: Tuesday 22 January 2019

  • ​​Italy reaches budget agreement while France may overstep the mark
  • European Central Bank lowers growth expectations
  • Brexit uncertainty still dogs the UK
By Halo Financial Team

The story so far…

The peak and trough of the last three months between the Pound and the Euro have each involved major Brexit events. The three-month high of 1.150 in mid-market rates came on 14th November after European Union officials agreed Theresa May’s draft Brexit deal. The low of 1.103 was reached on 12th December when the confidence vote in the Tory leader was held.

Italy reaches budget agreement

After months of negotiation, Italy has reached a budget agreement with the European Commission. In October, the commission rejected the Italian budget drawn up by Italy’s popularist government. Both Lega Nord and its Five Star Movement partner campaigned during the recent election campaign for increased spending on infrastructure and social welfare, as well as tax cuts for low-earners. After proposing draft budget deficit equivalent to 2.4% of Gross Domestic Product (GDP) for the next three years, in a bid to grow its economy, the commission instructed it to lower it to 2.04%.
 
Late in December, Italy accepted the spending plans. Italian Prime Minister, Giuseppe Conte, says the budget includes no major changes to key pre-election pledges, including a universal basic income and lower pension age. European Commission Vice President, Valdis Dombrovskis, says, “The Italian government has come a long way, only a few weeks ago there was confrontational rhetoric.” But he went on to say the “borderline compromise” does not solve Italy’s long-term economic issues. The deal means the Commission can avoid taking disciplinary measures against Italy, as long as the measures are followed through.

France may breach budget stipulations

Just as Italy is reaching an agreement on its budget, France is the spotlight for the next budget deficit breach. President Macron, in an apparently futile effort to appease the tax protectors, has agreed to a number of spending plans which, it is estimated, will cause France to breach EU rules on budget deficits; the same rule that Italy was keen to flout. The future impact on the Euro will probably have more to do with the intra-EU wrangling than any financial effect.

ECB lowers growth expectations

European interest rates look set to remain at their present benchmark refinancing rate of 0% until at least the middle of 2019, the European Central Bank (ECB) believes. The timing of any move depends upon inflation, which it aims to be around 2% in the medium term. The
€2.6 trillion Quantitative Easing Asset Purchase Programme (APP) is ending at the end of 2018. This is not a trifling matter though.

Effectively sucking €2.6 trillion out of the EU banking system is an effective tightening of the money supply and that may delay the need for rate hikes but it will also have an impact on shares, bonds and bank finances. The timing and rapidity of these changes is extremely uncertain though.
 
Meanwhile, the ECB is enhancing its forward guidance on reinvestment. ECB President, Mario Draghi, says rising uncertainty means “the balance of risk is moving to the downside” and there is slower growth momentum ahead. Growth expectations have been lowered by 0.1% to 1.7% in 2019, with inflation also expected to be down 0.1% to 1.6%. Mr Draghi did not mention the US-China Trade war, or Brexit, but no doubt they were on his mind when he said growth would be limited, “owing to the persistence of uncertainties related to geopolitical factors, the threat of protectionism, vulnerabilities in emerging markets and financial market volatility”.
 
Extremely close up view of European currency


Stronger international role for the Euro

Meanwhile, plans have been made for the Euro to take up a “stronger international role” in a bid to boost the use of the currency and benefit European business. The European Commission has published plans to use the Euro more in strategic sectors, including energy, commodities and aircraft manufacturing. It has already adopted a recommendation to promote the wider use of the Euro in international energy agreements and transactions. This will allow European businesses to benefit from stronger autonomy and finance themselves with reduced exposure to legal actions taken by third country jurisdictions.

 
The policy change comes amid concern over “recent challenges” to “international rules-based governance and trade” following the US- China trade wars. Euro chiefs are calling for a new EU payment system and for more contracts to be conducted in Euros rather than US dollars, which has become “the predominant currency for derivative operations”. As Vice-President for the Euro and Social Dialogue, explains, “The Euro is a young but successful currency. The time has come for the Euro to develop further its global role. The Euro should reflect the Euro area’s political, economic and financial weight and support a balanced, rules-based international political and economic order. Today’s proposals are there to start a journey, which can only succeed if there is a joint effort from the EU, Member States, market participants and other actors.”

German business morale falls for fourth month

Business confidence has fallen for the last four months in Germany. The ifo institute says companies are unhappy about the current situation and future expectations, as its Business Climate Index fell one point to 101.0, a 27-month low. In manufacturing the business climate index fell markedly, as business expectations turned negative for the first time since May 2016. In the service sector, the business climate deteriorated considerably, with providers less satisfied with their current business situation and less optimistic about their business outlook. The index also edged downwards in the trade sector.

The only good news was in construction, where the business climate index remained at a very high level. Current optimism was higher than future sentiment. Germany’s economy fell back 0.2% in the third quarter of this year. However, its 2019 budget still balances and the government is set to post a surplus of €10 million this year. In November, German and French finance ministers proposed that the Eurozone should have its own budget in place by 2021 to help promote greater convergence.

Brexit uncertainty still dogs the UK

Britain leaves the European Union on 29th March 2019 and uncertainty still dogs the UK. In fact, the chances of a no-deal scenario have increased, with the UK government already spending an extra £2 billion on preparing for the possibility. It has even admitted in its technical notices that no-deal is no longer an “unlikely” option. At the same time, businesses who trade with the European Union have been warned that they need to prepare for a no-deal scenario.
 
There was initial optimism that a deal would be reached, but after Prime Minister Theresa May’s solution was unveiled at Chequers, serious doubts were expressed by ministers, with some resigning. There was good news when EU leaders approved the terms, but as weeks went by, more British MPs opposed the proposals, mainly because of issues with the idea of an Irish backstop – a last resort to keep an open border.
 
In December, enough Conservative votes were submitted to the 1922 committee to warrant a vote of confidence in the leader. Mrs May won that vote, but a third of backbenchers voted against her. If there is no Brexit deal, the UK is likely to see major disruption from transport and travel, visas and border access, security, availability of food and medicines and more. Trading costs are likely to increase and the UK’s top five business groups have called on the government to prevent a no-deal scenario. They say, “Businesses have been watching in horror as politicians have focused on factional disputes rather than practical steps that business needs to move forward. The lack of progress in Westminster means that the risk of a ‘no-deal’ Brexit is rising. Businesses of all sizes are reaching the point of no return, with many now putting in place contingency plans that are a significant drain of time and money. Firms are pausing or diverting investment that should be boosting productivity, innovation, jobs and pay, into stockpiling goods or materials, diverting cross border trade and moving offices, factories and therefore jobs and tax revenues out of the UK.

Being prepared – for every eventuality

While many companies are actively preparing for a ‘no deal’ scenario, there are also hundreds of thousands who have yet to start – and cannot be expected to be ready in such a short space of time.” They go on to say the responsibility to find a way forward now rests directly with 650 MPs in Parliament. “Nobody wants to prolong the uncertainty, but everyone must remember that businesses and communities need time to adapt to future changes.
 
“As the UK’s leading business groups, we are asking MPs from all parties to return to their constituencies over Christmas and talk to their local business communities. We hope that they will listen and remember that when they return to Parliament, the future course of our economy will be in their hands.”
 
Theresa May says she intends to make whatever option is reached work. “Let’s be clear about this, under ‘no-deal’ there would be some short- term disruption. It’s our job as the government to make sure we make a success of no-deal, just as we make a success of getting a good deal.” In the week beginning 14th January, MPs are set to vote on the Brexit deal. Meanwhile, opposition MPs are seeking to add an amendment to the finance bill that would only allow a no-deal if members of Parliament voted for it. That will also be decided by MPs once they return from their Christmas holidays.

More to worry about than just Brexit

Brexit is adding to the UK’s economic difficulties. In December, there was bad news about the economy, with the current account deficit reaching a two-year high of £26.5 billion or 4.9% of GDP in Quarter 3, 2018. This was up £6.5 billion on the previous three months. At the
same time, UK real household disposable income stagnated, according to the Office of National Statistics figures. As a result, households borrowed more and the savings ratio reached its third lowest at 3.8%, down 0.3% on the previous quarter. It was the eighth quarter in a row that households spent more than they earned. Businesses also held back in the light of Brexit with investment down 1.1% quarter-on- quarter to £46.9 billion. In the last year, investment is 1.8% lower. In  fact, it has fallen three quarters in a row for the first time in 10 years, but there was some good news. UK Public Sector Net Borrowing fell to £7.2 billion in November 2018, £900 million less than a year earlier. It is the lowest November shortfall since way back in 2004.

What next for Sterling-Euro?

The same issues that dominated GBPEUR over the last three months are still set to steer the course of the currency pairing over the next three months. The Italian economy and budget, the performance of the German and French economy and business sentiment and in the UK,
Brexit, Brexit, Brexit.

Technical guidance for Euro buyers

GBPEUR has been trading in a well-defined range of 1.10/1.1550 since September 2017. Currently the exchange rate is bumping along the bottom of this range and at this point, there is no reason to believe that the lower level will not hold once more. Momentum indicators are
pointing lower and are not yet indicating that it is oversold, but for now, protection should be left below 1.1000 regardless of your timescale. On the upside 1.1200 is the first level to target followed by 1.1550/1.1600, which has not been breached for 16 months.

Guidance for Euro sellers

The market is still range bound, albeit bumping along the bottom of the long-term range. It may be prudent to reduce exposure close to current levels if you have a near-term requirement and certainly if the price heads towards 1.1000. A sustained break of this level would suggest a quick test of 1.0740.

Sterling-EUR Quarterly Jan-Mar 2019 Chart - Halo Financial

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