What will drive GBP/EUR exchange rates next?

The Pound to Euro exchange rate has continued to slide, presenting headaches for Euro buyers with Pounds. What seemed unthinkable a few months ago has now become a reality. What will be the main drivers on the rate for the coming weeks and months and just how low could this go?

Written by Jonathan Watson, Associate Director – Foreign Currency Direct

Sterling Outlook

The one element that had helped prop up the Pound had been the prospect of the Bank of England raising interest rates down the line. Last week’s Quarterly Inflation Report and interest rate decision confirmed what many had expected and effectively ruled out any interest hike for now. Combined with the tremendous political uncertainty since the UK election and Brexit vote, the Pound seems highly likely to be on the back foot for the foreseeable future.

Another element which has been helping the Pound has been consumer spending which has largely driven the economy since the vote last June. However rising inflation caused by the weak Pound is now really starting to bite into retail spending and both business and consumer confidence and spending are falling.

With a sub-prime crisis feared for the UK car industry and total new car sales down for the fourth consecutive month, this once staple element of the UK economy, so heavily relied on to boost GDP (Gross Domestic Product) figures since June 2016, could now be under threat.

There is speculation that the weaker Pound will cause inflation to rise which will reignite calls for an interest rate hike down the line. However, with the Bank of England having been threatening to raise interest rates since 2008 but to no avail, I do not think this will be happening anytime soon. Initially it will only be reversing last year’s cut of 0.25% so I don’t expect any major rises.

If you need to buy Euros with Pounds there could be some unexpected spikes in the value of sterling if the inflation data rises which does seem probable. However, to be holding on waiting for this to happen could be a potentially risky strategy, as I am sure any Euro buyer since the UK election will agree.

Euro Dominance

For Euro buyers with Pounds the pain doesn’t just stop with the Pound. The Euro has found itself in an ever improving position as it time and time again defies the critics. At the beginning of the year there were still serious concerns over economic growth, however, the Eurozone is now growing much faster than the UK, registering 0.5% versus the UK’s 0.3%. It is not just in economics that the Eurozone is outpacing the UK; politically the Eurozone has become a real haven for investors because of the relative political certainty.

At the beginning of the year there were fears about right-wing populism taking over in France or the Netherlands, just as it had in the UK and US. These fears were neutralised and it has sent European stocks, bonds and the currency soaring. With Angela Merkel expected to secure victory in the German elections on 24 September, it appears that little will unsettle the Euro’s dominance in the near-future.

Even the Italian banking crisis and the Greek debt problems have dropped out of the headlines with lots of work to smooth their concerns. Yet further Euro strength could be ahead with the European Central Bank seeking to ‘taper’ their QE (Quantitative Easing) purchases and ultimately put themselves on a path to raising interest rates, although the taper does, in my opinion, also have the potential to weaken the Euro. When the US started to taper their QE purchases a few years ago the US Dollar weakened dramatically and a similar scenario, whilst not part of most analysts’ central forecasts, is a real possibility.

Where next for GBP/EUR exchange rates?

Often with exchange rates it is just when it all looks like a one-way bet we see something unexpected occur and markets quickly change direction. For now with the Pound suffering from its Brexit-induced weakness, and the Euro benefitting from being the ‘best of the worst’, GBP/EUR seems likely to be confined to the more recent ranges of 1.10-1.14.

However a further improvement in Eurozone data and a deterioration in UK political sentiment could easily tip the scales below 1.10. Many of the banks have predictions in place for near to parity for the year end and these cannot be easily ruled out for now.

Should the ECB continue with their policies and start the taper we really could see further large shifts catching Euros buyers with Pounds unaware. All in all if you have Euros to buy with Pounds then some form of defensive strategy is best to try and limit your exposure to what appears like a market which will only work against you.

Euro sellers should continue to see a favourable market for their transactions, but nothing should ever be taken for granted on the currency markets.

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*Exchange rates referenced in this article are interbank rates and indicate where the market is trading to show the performance of a currency pair. They are not indicative of tradeable rates.