GBP/EUR: Macron and Merkel victories lighten the EUR load – Lloyds Bank

Gajan Mahadevan, Quantitative Strategist at Lloyds Bank, explains that in spite of all the political event risk so far this year, GBP/EUR remains confined to a 1.13 to 1.20 range.

Key Quotes

“The pair tested the upper bound of this range in mid-April following UK PM Theresa May’s surprise decision to call for a snap general election. However, Emmanuel Macron’s victory in the French presidential election and German Chancellor Angela Merkel’s impressive performance in the regional elections and recent polls, drove the market to ‘re-price’ the risk premium associated with a European outlier event. This led GBP/EUR to fall back to the middle of its range.”

“The decline in European political risk combined with the robust performance of the Euro Area economy and unexpected uptick in core Eurozone inflation, may sway the European Central Bank (ECB) to amend its forward guidance and possibly even tighten policy sooner than the market is currently anticipating. In fact, our economists expect the ECB to remove reference to its downside interest rate bias at its next monetary policy meeting in June. In contrast, the Bank of England (BOE) is likely to leave policy rates unchanged for the foreseeable future, especially after the downward revision to its UK economic growth forecast in May’s Quarterly Inflation Report.”

“Upcoming event risks to be wary of include the UK General Election and June’s ECB meeting, both of which take place on 8th June. While we continue to expect GBP/EUR to remain within its broad range, in light of the dissipation of European political event risk and the potential knock-on impact on the region’s monetary policy, we feel the pair is likely to move moderately lower.”

“As such, we forecast GBP/EUR at 1.16 for year-end and 1.14 for end-2018. However, the progression of Brexit negotiations, alongside other risks, leaves the pair vulnerable to significant bouts of volatility. This uncertainty is well reflected in analysts’ expectations, which continue to show significant divergence (end-2017: LBCB – 1.16, high – 1.35, low – 1.00).”