Thursday, October 22, 2020

Sterling may show some strength in the short-term, but its longer-term outlook remains weak

  • Euro
  • Pound
  • European Central Bank
  • Bank of England


Analysts’ Pick: Sterling may show some strength in the short-term, but its longer-term outlook remains weak

  • EUR/GBP may have some downside in the short-term as economic data and speculation for an ECB easing cycle is likely to outweigh that of the UK
  • In addition, more positive Brexit news – which we expect due to aligned incentives for at least a barebones trade deal – is more likely to benefit sterling than euro
  • However, our longer-term outlook remains mostly the same – bullish on EUR/GBP – as the outlook for the UK in the medium-to-long-term is worst off when compared to that of the EU bloc

While Brexit negotiations and the daily count of Covid-19 cases in both the UK and EU remain in the headlines for both blocs, recent economic data from both blocs also suggest some possible downside potential in the medium-term as the European Central Bank (ECB) and the Bank of England (BoE) faces more pressure for another easing cycle.

The overall trend for EUR/GBP remains bullish, but there may be some room for downside


For the UK, September's inflation rate released yesterday came in a touch under expectations. Importantly, the reading reflected the end of the British government's Eat Out to Help Out initiative to subsidise consumer spending in restaurants and pubs during August. Details from the Office of National Statistics' (ONS) report shows that an imbalanced recovery in demand across sectors continued to persist. While transportations, more specifically air travel had a good reading compared to a year ago (-19.3% vs -33% a year ago), the more likely driver for the period was the exclusion of destinations that consumers were restricted from. This suggests that more downward pressure may be omitted from the short-term as travel restrictions continue to distort the data set. Low oil prices also had a large downward impact on the deficit, while the food and hotel segment advanced 3% compared to the 4.7% in August. The ONS also noted that a full rebound in prices in the hospitality and leisure has yet to happen as a result of the government's temporary sales tax relief (5% vs 20%) for the sector. While inflation is expected to continue to rise (especially as we assume that at least a bare bones post-Brexit trade deal between the UK and EU will eventually be made), the question is sustainability and balance across industries, which leads us to the incoming spike in unemployment.

The Covid-19 situation in the UK has now worsened in comparison to September. While there were signals earlier in September that the count of Covid-19 cases was accelerating, it has now materialised at a much faster rate since the start of October. The resulting response of the government to reintroduce varying levels of restrictions, while not to the extent of that earlier in the year, is still expected to add a dent to the country's economy. The BoE has yet to account for this in its September meeting, suggesting that a downward revision to its forecasts is due. In addition, we've yet to seen the impact of the unwinding of the furlough scheme by the government that is due at the end of the month, which should cause a spike in unemployment as the British government cuts back on its subsidies. In our previous report we also touched on the effectiveness of the new extended Jobs Support Scheme, which from our point of view, will be unable to protect the jobs of lower skilled workers who are already bearing the grunt of the negative impacts of the current pandemic. More specifically, the new Tier system for lockdown restrictions suggests that the dining and leisure industry will likely be impacted the most since they may not be forced to closed, rendering them not eligible for the extended Jobs Support Scheme benefits.

Finally, the switch in tone from BoE Governor Andrew Bailey on negative rates also suggests that the BoE is more likely to switch towards a more dovish tone in upcoming meetings even if an easing cycle is not implemented by the end of the year (Bailey now does not out rule the possibility of negative interest rates in the UK, contrasting former governor Mark Carney's stance). Another likely scenario is for an expansion of its asset purchase program, which will reach its ceiling by around early-November at its current pace.

Covid-19 cases really started to accelerate in the beginning of October, triggering lockdown measures from the UK government


The BoE’s asset purchase program is set to reach its upper limit by early November at the current pace


Similarly for the ECB, we've also seen a reversal in tone from officials on the EU's economic recovery. The recent meeting minutes also did suggest that policymakers were not as optimistic as ECB President Christine Lagarde's tone during her last post-meeting press conference. In addition, the severity of the Covid-19 cases in the bloc has also continued to spike up over the past couple of weeks. Now daily Covid-19 cases in Germany and Italy has risen at figures higher than that seen in March and April. Italy's Lombardy, the country's most populous region will move into a curfew from 11pm to 5am, while other regions such as Rome and Lazio are also reportedly considering implementing curfews as soon as Friday to help curb the spread of the virus. These restrictions are in addition to various others in member countries such as Spain, France and Czech as the second wave of infections in the bloc continues to put pressure on their respective health systems.

Covid-19 Cases in Italy and Germany jumped over the past week adding to the list of countries with a higher count of daily Covid-19 cases since April


As a result, we expect incoming data for the region to mostly skew the euro towards the downside. Gfk's consumer confidence index for November in Germany slipped to -3.1 (E: -3.0, P: -1.7) earlier today, as the survey already starts to show the growing concern of the accelerating pace of daily Covid-19 cases in the country. Today's consumer confidence index for the Eurozone for October is likely to contract from September, but is unlikely to fully reflect the severity of the current situation in the EU. This may be the case for PMI data from Markit for October for the EU tomorrow as well, however we do expect the readings to still be worse-than-expected across the board for EU countries due to increased uncertainty over potential lockdown measures. The resulting impact should be some downward pressure on the euro in the short-term as a result. Worse-than-expected data is more likely to influence the ECB's monetary policy decision next week as well, which we view to already be mostly in the favour of a dovish forward guidance or additional easing via expansion to its Pandemic Emergency Purchase Programme (PEPP).

For the EUR/GBP, the key driver in the short-term will be progress on a post-Brexit trade deal. While both parties still have key issues of an agreement to work out, we continue to view the more likely possibility to be some form of a trade deal to be made. This is mainly due to the incentives that will drive negotiations, which we have seen inklings of over the past few weeks as both EU leaders and the UK implicitly put efforts into forming a deal despite explicit statements that they were ready for a hard Brexit. This should result in sterling continuing its recovery over the euro in the short-term, possibly driving EUR/GBP closer towards the 0.8900's level. This downside for the currency pair is however, likely to be limited by the medium-to-long-term downside outlook for sterling relative to the euro due to the combination of a more probable additional BoE easing cycle, pressure on businesses from higher costs for exporting to the EU (since we assume that a barebones trade deal between the EU and UK will be made) and an impending spike in unemployment in the UK. This skews our longer-term outlook for EUR/USD to remain in an overall upward trend channel, resulting in a limited downside for the currency pair in the short-term.

Technical Analysis:


The short-term momentum position for EUR/GBP looks to be skewed towards the downside, with MACD entering into a bearish trend. But with RSI hovering at the 37.00 level suggests that there will probably be some resistance from euro bulls before we see additional downside. That said, as we view fundamentals to be tilted in favour for sterling in the short-term, there may be more room for the pair to dip lower before a rebound is due with the RSI touching the oversold region at 30. Furthermore, the 200-day moving average continues to signal a bullish trend for EUR/USD, which we fundamentally agree with in the longer-term as a result of a negative economic outlook for the UK. The 200-day moving average should provide that lower limit for downside, as it triggers buy orders from speculative traders.

Support: 0.9000 / 0.88943 / 0.8867

Resistance: 0.9047 / 0.9116 / 0.9148

EUR/GBP Chart (H4)