by Anooja Debnath and Charlotte Ryan
20 - 12 - 2016, 9:54 π.μ. EET
Bloomberg
For analysts trying to plot the course of the pound against the euro in 2017, the key decision is judging which side of the English Channel will see greater political turbulence.
Strategists are trying to pinpoint whether the U.K.’s exit process from the European Union or the rise of populism in the rest of Europe carries the bigger risk. The dichotomy is evident in Bloomberg’s survey of currency analysts, where the range between the highest and lowest year-end forecasts for euro-sterling is the widest going into a new year since at least 2006.
With central banks buying bonds and suppressing borrowing costs, currencies have become the main way investors reacted to political risk in 2016. Sterling is on track for its biggest annual decline against the euro since 2008, and the median forecast in a Bloomberg survey of economists sees the pair reaching 86 pence by the end of next year, with a range of 73 pence to one pound per euro.
Both sterling and the euro fell for a second day versus the dollar after incidents in Germany and Turkey on Monday heightened geopolitical tensions. German authorities began investigating what they called a “probable terrorist attack” on a Berlin Christmas market. The U.S. currency also gained after Andrey Karlov, Russia’s ambassador to Turkey, was shot dead in Ankara.
“Clearly there’s a lot of political risk on both sides of the English Channel over the course of the next 12 to 24 months,” said Jeremy Stretch, head of Group-of-10 foreign-exchange strategy at Canadian Imperial Bank of Commerce in London. “The legacy of 2016 will be that traditional presumptions in terms of politics and political risk have been turned upside down.”
The U.K. currency was little changed at 83.92 pence per euro as of 7:52 a.m. in London. It slipped 0.1 percent to $1.2381.
While the pound plunged to its lowest level versus the dollar in more than three decades after the U.K. voted in June to leave the EU, recent economic data have proven resilient. That’s prompted BlackRock’s deputy chief investment officer of global fundamental fixed income, Scott Thiel, to be positive on sterling. “So long as we don’t go down the road of a hard Brexit, the pound will continue to react relatively favorably,” he said at a media briefing last week.
The U.K. currency may also benefit from political turmoil across Europe. France’s National Front leader Marine le Pen, who wants to take the nation out of the euro, is likely to enter the two-person run-off vote for the presidency in May, polls show. In the Netherlands, far-right politician Geert Wilders is leading in the polls, despite being found guilty of inciting discrimination this month. Meanwhile, Italy faces both general elections and a referendum on labor reform. Some analysts say this means the euro may suffer more than sterling.
“Through the first half of next year, we think the main story will be that the pound benefits from the market’s focus switching more toward the political risk in Europe,” said Lee Hardman, a London-based foreign-exchange strategist at MUFG. “The pound could benefit relative to the euro as it looks comparatively safe during that period.” He forecasts the euro will drop below 80 pence during the first half of 2017, a level not seen since Britain’s decision to quit the EU became known.
The pound may also be underpinned by any delays to Article 50 of the Lisbon Treaty, which will start the process of Britain leaving the EU, according to BlackRock’s Thiel. Prime Minister Theresa May has pledged to start the Brexit process formally by the end of March, a deadline which Thiel said was “challenging.”
Not everyone is so positive on the pound. For CIBC’s Stretch, a likely “deterioration in the macro fundamentals” coupled with Brexit-related uncertainty means the pound is in for a rough ride.
“Any sterling rallies we see into year-end provide better levels to go short,” Stretch said. The pound could weaken toward 86 pence per euro by March 2017, he said.
Sterling is the year’s second-worst performer among major currencies, beaten only by the Mexican peso, and has weakened 12 percent against the euro and 15 percent versus the dollar this year. Traders assign about a 55 percent chance of euro-sterling reaching 80 by the middle of 2017 and only a 3 percent chance of parity in the same time-frame, according to Bloomberg’s options calculator.
Aside from the political risks, the pair’s outlook for 2017 may be determined by technical levels, according to Bloomberg technical analyst Sejul Gokal.
Key support for EUR/GBP is seen at 0.8176-17 (50 percent retracement of the 2015-2016 rally and the April 2016 high); 0.7883 (61.8% Fibonacci retracement of the 2015-2016 rally); 0.7565-21 (May 2016 low, 76.4% retracement of 2015-2016 rally) Resistance for the pair seen at 0.8857 (Nov.4 2016 low), 0.9049 (Nov.2 2016 high), 0.9415 (Oct. 7 2016 high)
Positioning
Leveraged investors and interbank desks went short euro on the break of 0.8700 support versus the pound and still hold on to the larger part of their position, three traders in London and southern Europe say, who asked not to be named as they are not authorized to speak publicly
Real money names look to fade rallies in the pair, albeit interest for the time being remains subdued; fast money accounts were seen buying the dip in the past few sessions, one of the traders adds
Euro sentiment versus the pound, as seen in the three-month 25-delta risk reversal, hit 27 basis points in favor of euro calls over puts on Dec. 15, the most bearish level this year. The risk reversal is a measure of market sentiment and positioning and becomes euro supportive only on tenors greater than one year
Some information comes from FX traders familiar with the transactions who asked not to be identified because they aren’t authorized to speak publicly
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