June 29, 2021

Sterling leads Euro 1-0 at half-time in dull encounter but could extend advantage

BY Olivier Desbarres

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  • With England due to play Germany in the last-16 round of the Euro Championships in a few hours time, now is a good time to revisit the Sterling-Euro exchange rate.              
  • Football fans will be hoping for a pulsating sporting encounter rich in history while traders will be hoping that the GBP/EUR cross, which is currently trading in the middle of a narrow 7-week range of only 1.4% and has exhibited very little volatility, will throw up some excitement of its own in the second half of the year.     
  • Our core scenario is that the GBP/EUR cross will fall short of setting the FX world alight but will appreciate slightly in Q3, for three inter-connected reasons.                    
  • First, international travel restrictions in the UK and Eurozone, while admittedly fluid, are likely to result in far smaller net outbound tourism from the UK this summer than compared to previous “normal” years, in our view.                  
  • If this holds true, the typically very large UK tourism deficits, including with Eurozone countries, are likely to be far smaller than normal in July-August, which will could in turn up-end Sterling’s typical seasonal weakness versus the Euro in these two months.         
  • Second, we think these respective travel restrictions will help boost the UK economy, particularly if as per our core scenario the British government lifts all, or at least most remaining social distancing restrictions on 19th July. The UK is on track to have double-vaccinated 80% of its adult population by mid-July, with Eurozone countries on average still about six weeks behind according to our estimates.              
  • The upshot is that the GDP growth differential between the UK and Eurozone as measured by the Composite PMI, which has narrowed in the past two months, will widen again in coming months and push GBP/EUR higher, in our view.   
  • Finally, as a result of this (expected) relative pick-up in growth and inflation dynamics in the UK and Eurozone we think the risk is tilted towards the Bank of England’s monetary policy stance becoming increasingly less dovish relative to the European Central Bank’s.   
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