Brexit drives direction for GBP/EUR

Euro Highlights

• Euro interest rates may be kept on hold for longer

• Will Germany go into recession?

• May and Corbyn meet for Brexit talks

 

Sterling - Euro (GBPEUR) FX Technical Analysis

Since January, the Pound has risen considerably against the Euro on hopes that a no-deal Brexit could be averted. The Sterling low from January-March 2019 of 1.106 in typical mid-market rates came on 3rd January after a surprise announcement about a fall in revenue from Apple. The high of 1.178 was on 27th March, when the first round of indicative votes were cast by British MPs, on optimism that a no-deal Brexit could be avoided. As German Chancellor, Angela Merkel has said, a disorderly Brexit does not benefit the UK or Europe. "I’ve always said that I will fight until the last hour of the date in question for an orderly Brexit - that’s in the British interest but also in our interest.” For instance, growth in Germany in 2019 is forecast at 1.2%, according to the Federation of German Industry (BDI), but could reach just 0.7% if there is a disorderly Brexit.

Euro interest rates may be kept on hold for longer

European Central Bank (ECB) President, Mario Draghi, says interest rates could be kept on hold for longer than expected, if required. The dovish comments came at a Frankfurt monetary policy conference where Mr Draghi says, "adjusting our rate forward guidance" is an option to curb inflation. The last year has seen a loss of growth momentum in the Euro area, which has extended into 2019, he admits. “This has been predominantly driven by pervasive uncertainty in the global economy that has spilled over into the external sector. So far, the domestic economy has remained relatively resilient and the drivers of the current expansion remain in place. However, the risks to the outlook remain tilted to the downside.”

In March, the ECB announced a new initiative to stimulate bank lending and a potential delay in interest rate rises. Mr Draghi says, “The monetary policy measures we took at the last Governing Council meeting reflect this assessment. In the face of a weaker growth outlook, they help maintain the accommodative policy stance that we managed to preserve last year as we rotated our instruments from net asset purchases to forward guidance. Our policy thereby continues to accompany the economy on its path towards our inflation objective.”

As the economy weakened in the second part of last year, it was unclear whether the fall in growth was temporary or more lasting. In 2016, the European economy went through a similar “soft patch” triggered by a contraction in world trade. “At that time, the strength of the domestic economy was able to shield the recovery from external uncertainties. The key question is whether, with monetary policy continuing to support the expansion, domestic demand will remain as resilient today.”

Although forecasters have slightly downgraded their projections for investment growth this year – from around 3% to around 2.5% – the fundamentals are in place for investment to rebound, if global growth stabilises, he says. The weakening growth picture has naturally affected the inflation outlook. ”Our projections for headline inflation this year have been revised downwards and we now see inflation at 1.6% in 2021. Slower growth will also lead to a more muted recovery in underlying inflation than we had previously expected.”

But the ECB is confident that the sustained convergence of inflation to its target rate has been delayed rather than derailed. However, “substantial accommodation” is still needed to secure the path of inflation convergence and this is reflected in the ECB’s past monetary policy decisions, he says. “In parallel to winding down net purchases, we have strengthened our forward guidance on interest rates and bond reinvestments. This has allowed us to rotate the instruments used to set the policy stance, while leaving the stance itself broadly unchanged.” Interest rate expectations are anchored to the ultimate inflation objective, and thereby acts as an “automatic stabiliser” in the event of downside risks emerging.

At its last meeting, the Governing Council decided, based on the weaker outlook for inflation, to extend its rate guidance “at least through the end of 2019”. “That in turn implies that we will continue to keep the very sizeable stock of assets bought under the asset purchase programme unchanged for even longer.” The Governing Council also decided to launch a new series of targeted longer-term refinancing operations (TLTRO-III) to preserve favourable bank lending conditions. “These decisions ensure that our policy stance remains accommodative in the face of a weaker growth outlook.”

He concludes, “The bank will ensure that monetary policy continues to accompany the economy by adjusting its rate forward guidance to reflect the new inflation outlook. But the commitment to our objective also implies alertness to future risks and a readiness to respond to them should the medium-term outlook continue to deteriorate significantly. In this case as well, the ECB will adopt all the monetary policy actions that are necessary and proportionate to achieve its objective. We are not short of instruments to deliver on our mandate.”

Will Germany go into recession?

Hit by slowing growth, some economists are suggesting the German economy could go into recession at the end of the year. However, one investment bank says that could benefit Europe by kick-starting a programme of investment. Steen Jakobsen, chief economist and chief investment officer at Saxo Bank says following a period of austerity, "It gets them back in the game.” Germany had grown complacent, but any expansion in spending could benefit Europe as a whole, says the Danish bank. Germany narrowly missed recession in Quarters 3 and Quarter 4 of 2018, when GDP fell 0.2% in the third quarter and was at 0% in the fourth. A major contributor to the slowdown in growth has been the effect of US trade tariffs and a downturn in confidence on the car industry

May and Corbyn meet for Brexit talks

In a surprise move, UK Prime Minister, Theresa May, agreed to meet with opposition leader Jeremy Corbyn in a bid to come up with an agreed approach over Brexit and get it approved by parliament. Mrs May says her Brexit deal must be part of the solution. If the two leaders cannot reach agreement, various options will be put to MPs "to determine which course to pursue".

Mrs May is also meeting Scottish First Minister, Nicola Sturgeon and Welsh First Minister, Mark Drakeford. The development comes after MP rejected all Brexit options under consideration for the second time in a week, MPs – making a no deal-Brexit “nearly inevitable”. The move came in the second batch of Indicative Votes set before the House of Commons on Monday 1st April.

All four of the Indicative Vote options, designed to find which courses of action are most acceptable to MPs, were defeated in the Commons. The same happened the week before. The closest option to being won was from veteran Tory Ken Clarke, for a permanent customs union. It was defeated by just three from 273-276. Last week, it was lost by six votes. After the votes, Brexit Secretary, Stephen Barclay, said, “The default legal position is that the UK will leave the EU in just 11 days’ time. To secure any further extension, the Government will have to put forward a credible proposition to the EU as to what we will do with that extra time… The only option is to find a way through which allows the UK to leave with a deal.” The Pound immediately dropped on the outcome, falling against the US Dollar from 1.311 to 1.304 in typical mid-market rates.

A week earlier, on 29th March, the day that Britain was supposed to be leaving the European Union, MPs ruled out Prime Minister Theresa May’s Brexit withdrawal agreement for the third time. In a desperate attempt to gain some momentum, Mrs May split the withdrawal element of her deal from the political part. But MPs still voted the ‘blind Brexit’ deal down by 344 votes to 286 - a majority of 58. There are now fears that with the UK set to leave the EU on 12th April at time of writing, there is not likely to be enough time to legislate for a deal. If the UK wanted a further extension, it would need to hold European elections, says Mrs May. “The implications of the House’s decision are grave. The legal default now is that the United Kingdom is due to leave the European Union on 12th April.

An emergency EU summit has been hastily arranged for Wednesday 10th April. The European Commission says, “a ‘no-deal’ scenario on 12th April is now a likely scenario. In a bid to finally get her EU withdrawal agreement approved, Mrs May put forward the withdrawal agreement part of her Brexit deal without the political declaration. Even so, the European Commission said had the deal passed, the UK could leave the European Union without passing the political declaration. There is a bid for a longer extension until 30th June, a date that has already been rejected by the EU. British business leaders again condemned the situation as “a failure” and “a disaster” for the UK economy and jobs.

Mike Cherry, the chairman of the Federation of Small Businesses, says, “On the day that we were supposed to be leaving the European Union, all we have is yet another political failure to chalk up.   Responsibility for this deepening political crisis lies squarely at the feet of politicians who have clearly stopped listening to the business community. Stephen Phipson, Chief Executive Officer of the manufacturers’ organisation, Make UK, says, “This now makes the nightmare of a ‘no-deal’ scenario more likely than ever. This would be a disaster for the UK economy as a whole and for the 2.7 million manufacturing jobs around the UK.”

What next for Sterling-Euro?

There’s only one game in town at the start of the second quarter – the outcome of Brexit. This will affect both currencies, although changes in the Pound are likely to be more profound. In many ways, Europe will be glad to see the back of Brexit, so it can concentrate on its own issues.

Technical guidance for Euro buyers, by Ricky Nelson, Head of Corporate Dealing

The trend line that has been in place since the beginning of the year – currently around 1.1750 – has held and the currency pair is correcting lower. Buyers should target ahead of the trend line resistance in the short term for at least part of their exposure. Support is now at 1.1500/50, which held really well throughout last year and should provide ample support for the time being. A break below here would be disappointing and may trigger sharp losses towards 1.1300.

Guidance for Euro sellers

Trend line resistance above 1.1700 held yet again and sellers would be well placed to leave protection above here. I would suggest targeting 1.1500 support in the short term as this level held on numerous occasions last year and is likely to offer significant support. The momentum indicators would suggest that we are likely to test lower levels and a break below 1.1500 opens up a test of the recent channel low of 1.1000.

GBP-EUR movements to April 2019