Sterling – Euro Quarterly Forecast July – September 2015 Content: • General Election • Tensions in Greece affect the Euro • China could affect the world market • GBPEUR Forecast
Introduction With the Greek crisis in an on and off phase, China to stabilise its economy and uncertainty over the timing of interest rate rises in the UK, US and elsewhere, this is a good time to take a longer term look at the Sterling – Euro exchange rate and to put some of 2015’s volatility into context. Here we will cover some of the possible outcomes in Europe, external factors that will influence this currency pair and, of course, the improving UK economy and how that will directly impact the Sterling – Euro exchange rate.
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General Election Earlier this quarter, we experienced one of the most uncertain general elections within a generation with a hung parliament very much a possibility. Any political uncertainty tends to generate currency weakness, so it’s no surprise that we saw volatility and the Sterling - Euro exchange rate reach an eight year high at €1.40. Insurance costs against GBPEUR also rose to their highest in over three years. Upon confirmation of the election results, the Queen gave a speech with arguably the greatest potential to change the course of the UK economy; central to which was the vote on Britain’s membership of the EU - but would it be for better or for worse if Britain were to leave Club Europe? Assuming these new trade arrangements can be agreed, would overseas investors move from the UK to EU countries to avoid tariffs and levies? The answer is yes, some probably would. However, governments are well-versed in providing incentives for companies to invest and employ within their borders and it should be remembered that without EU constraints, the UK would be free to offer those incentives without any EU comeback. How Sterling would react is very interesting factor. The UK economy has continued to grow with jobless levels falling, inflation steady, and consumer spending and confidence on the rise. Many European countries are still struggling with 25% unemployment rates and zero or even negative growth. Consequently, the Pound has remained healthy. The UK’s biggest problem is productivity, which has suffered as jobs being created have tended to be more prevalent in low skill roles and in part-time or zero hour contracts. Cameron has some work to do to bring productivity up, which allows the Pound every opportunity to strengthen as long as overseas markets are strong enough to keep importing UK goods and services.
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Tensions in Greece affect the Euro Greece is still at the centre of everything in spite of the supposed agreement on the austerity measures that the EU demanded, the Greek people rejected and ultimately the Greek parliament approved. While this is only just beginning, the International Monetary Fund believes restructuring is just a delay of the inevitable. The IMF warns that Greece will reach a debt to economic output (GDP) ratio of 200:1 within two years if nothing changes. That may sound horrendous, and it is, but that level is already 165:1 and the Italian debt to GDP ratio is 133:1. Should we all be worrying about Italy; a country that constitutes 16% of the Eurozone rather than Greece which represents just 2%? So the two tier euro area remains a concern. Germany has an unemployment rate of roughly 4.5% whilst the average in the Eurozone at a whole is around 13%. Growth is equally disparate, Spain is forecast to grow by 2.7% in 2015, Germany is forecast to grow by 2.0% and yet Portugal is expected to deliver just 0.4% and both Finland’s and Italy’s economy are still contracting. The argument over the ECB’s ability to manage one currency for 18 dissimilar economies with one set of policies has never gone away. However, Greece’s problems have brought the issue right back into the spotlight. It isn’t going to go away in a hurry and that will keep any gains the euro makes to a minimum for now.
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Sterling The UK has the golden touch as far as economic success goes in this post-crash era. Britain’s unemployment rate is enviable and the economic growth is surprising good at 2.6%. The fact that wages are now starting to pick up is very encouraging and even more encouraging is that fact that all of this is happening while Europe (Britain’s largest export market) remains relatively flat. This would suggest we could see greater success if the EU starts to post improved growth data as well. The upside to a stronger Pound is lower inflation as the cost of imported goods is kept down. However, the downside is that it hampers exporters and UK goods to increase in cost for overseas buyers. That has a natural balancing effect on growth and we have not yet seen any substantial impact of that nature in this cycle. However, assuming UK growth continues to develop, that unemployment continues to fall and wage price growth stays reasonably subdued, Sterling has the capacity to continue to strengthen for a number of months to come. The caveat to this is that traders tend to think quite technically and, from a technical standpoint, the Pound is looking significantly overbought – excessively strong in other words. Some form of correction is probably overdue and that could knock 5% off the value of the Pound in no time at all.
In a broader context Global themes are dominating events in the foreign exchange market and events or news from the most unlikely places can impact the Sterling – Euro. Read on to find out what global themes are currently affecting GBPEUR.
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Export Growth Since 2011, the export growth figures have been more modest, slowing to 6.4% last year China is the second biggest importer of both goods and commercial services.
6.4%
5.4% Chinese Economy 11 key facts you should know....
For the European Union, China comes in third. And for the UK and the US, it is number four.
July’s export slump was deeper than economists predicted, while the nation’s index of producer prices declined 5.4 percent, the most since 2009.
(These are World Trade Organization figures, which treat the European Union as a single export destination.)
The devaluation of the Yuan is the largest since China’s modern exchange-rate system was introduced at the start of 1994.
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a year
The announcement suggests policy makers are now placing a greater emphasis on efforts to combat the deepest economic slowdown since 1990 and reduce the government’s grip on the financial system.
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Economy Grew
The economy grew at an average rate of 10% a year for the three decades up to 2010.
6.8% 2015
6.3%
$300billion
The exchange-rate intervention contributed to a $300 billion slide in China's foreign-exchange reserves over the last four quarters.
2016
The International Monetary Fund (IMF)'s most recent forecast is 6.8% growth for this year and 6.3% for 2016.
Estimates suggest that a 1 percent depreciation in the real effective exchange rate boosts export growth by 1 percentage point with a lag of three months. At the same time, a 1 percent drop against the dollar triggers about $40 billion in outflows.
6.4400 6.4300 6.4200 6.4100 6.4000 6.3886 6.3800 6.3700 6.3600 6.3500 6.3400 6.3300 6.3200 6.3100 6.3000 6.2900 6.2800 6.2700
From the turn of the century to 2011, there were only two years when China's exports did not grow by more than 10% and there were six years when it was more than 20%.
6.2600 6.2500 6.2400 6.2300 6.2100 6.2000 6.1900 6.1800 6.1700 6.1600 6.1500 6.1400 6.1300 6.1200 6.1100
March
Export Growth
6.4%
Since 2011, the export growth figures have been more modest, slowing to 6.4% last year China is the second biggest importer of both goods and commercial services.
5.4% 6
For the European Union, China comes in third. And for the UK and the US, it is number four.
(These are World-Trade Sterling EuroOrganization Quarterly figures, which treat the European Union as a single export destination.)
July’s export slump was deeper than economists predicted, while the nation’s index of producer prices declined 5.4 percent, the most since 2009.
April
May
June
July
August
Over 3 days in August the Peoples Bank of China devalued the Yuan by 3.86%, sparking fears of a new currency war in which countries try to weaken their currencies in order to achieve an export price advantage.
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China could affect the world market The sharp decline in Chinese share markets was halted by the People's Bank of China, who imposed an embargo on share sales. That was brought about by nervousness over Chinese growth data and the vast sums being withdrawn from China to be invested elsewhere. The Chinese authorities have also been busy; dumping billions of dollars’ worth of US treasuries but snapping up gold at the current deflated prices; some 600 tonnes of the shiny stuff at the last estimate. China’s economic impact is immense; they are the largest consumers of raw materials in the world and that affects the countries that export raw materials. Australasia, south America and Africa are all affected by a Chinese decline and that has implications for every other currency as well.
Interest rates As mentioned above, after 6 years or so at virtually zero interest rates across the globe, there will come a time when central banks will start hiking their base rates to ‘normalise’ the situation, as they put it. When that process will start and at what pace it will happen is cause for a huge amount of speculation. At the time of writing, the general consensus is that the UK and US base rates will start to edge higher around the end of 2015 and maybe into the early part of 2016. Even the hint that this may be so has been enough to strengthen the USD and GBP which will mean the euro will effectively look weaker.
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At the same time, the Reserve Bank of New Zealand is lowering its base rate and the Reserve Bank of Australia is being pressed to do likewise. These changes cause investor funds to be diverted towards the greatest yield and that influences the value of the underlying currencies. With so little yield being on offer, this will become a major theme over the latter part of the year. As the Euro is offering interest yield based on a base rate of just 0.05%, it doesn’t exhibit an attractive figure when base rates are in the 2% to 30% range in Australasia for example. That weakens the euro’s attractiveness to international investors and keeps pressure on the euro to remain weak.
Regulation It is pretty obvious that regulators were left with very red faces after the debacle of the 2007/2008 financial crash. Too little regulation and large loopholes in those regulations that did exist, contributed to the crisis and we have seen an audible scrabbling by regulators to fix the stable door whilst the sound of hooves from a bolting horse echo in the distance. Increasing levels of regulation are likely to have unexpected consequences as investors seek to use the least hassle routes to move their funds. Quite how this will impact individual currencies is hard to predict but tighter controls generally lead to less inbound investment. It may not be the main factor but it will be influential.
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Forecast Sterling Euro broke though the long term support line in August and has now almost fully retraced the move from the April low of 1.3367 to the July high (1.4413). The price action would suggest that it is a little overdone at these levels with the RSI’s turning up from oversold levels towards the end of the month. A decent base has formed around 1.3550 and I would expect that to offer support in the near term having bounced off of that level 5 times in the past 2 weeks. If this level does not hold then 1.3350 will be tested very soon. If we do move back to higher levels after a period of consolidation. 1.3750 (61.8% Fibonacci) will provide initial resistance followed by the psychologically important 1.4000. For now the exchange rate is trading a narrow band between 1.3550 and 1.3750 awaiting for clearer trading signals.
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