Europe’s single currency has hit its strongest level against sterling in eight years, reflecting the diverging economic outlook for the UK and the eurozone and its implications for their respective central banks’ policymaking.
The euro rose above 92 pence on Wednesday on the back of a flurry of better than expected eurozone economic indicators, reaching a level not seen since October 2009 — with the exception of last autumn’s momentary “flash crash”.
Sterling has underperformed most other major currencies this year, led by the euro and Scandinavian exchange rates.
The euro has rallied more than 10 per cent from a low for the year of 83 pence back in April, a run that has sparked some in the currency market to call for parity between the two currencies as the UK negotiates its exit from the EU.
Hans Redeker, global head of FX strategy at Morgan Stanley, forecasts euro-sterling parity by the end of this year, with a further rise to £1.02 per euro in the first quarter of next year.
He blamed much of the sterling depreciation on the uncertainty around Britain’s plan to exit the EU, saying the economic environment “looks increasingly fragile” as “investment spending is softening and export strength is underperforming”.
The possibility of a leadership challenge to prime minister Theresa May at the Conservatives’ annual conference in October was fuelling investors’ concerns, Mr Redeker said, and “the question of [political] leadership results in an additional risk discount” to sterling.
In sharp contrast to the political clouds that are overshadowing the UK’s economic outlook, the eurozone’s economy is going from strength to strength.
Economic data published on Wednesday showed activity picking up in August after a brief hiatus in July. The manufacturing sector has proved particularly strong, with the rate of private sector expansion running at around the best seen over the past six years.
The eurozone economic releases also pushed the euro stronger against the dollar, shedding recent losses to rise 0.2 per cent to $1.1782.
UK economic data has been resilient recently, with better than expected public finances and rising retail sales. However productivity is declining and the political uncertainty of Brexit is weighing on markets.
The renewed weakness in the pound also reflects investor expectations that the Bank of England will maintain its current low interest rate policy for some time. In the wake of the Bank meeting earlier this month, the policy-sensitive two-year gilt yield has fallen back below the current base rate of 0.25 per cent.
In contrast, investors are primed for the European Central Bank to signal a moderation in bond buying from its current monthly pace of €60bn in the coming year as the economy gains momentum. The ECB meets on September 7, while markets also await Mario Draghi speaking at Jackson Hole, the annual symposium for central bankers, on Friday.
Not all market observers agree that sterling-euro is heading for parity, however. Analysts at UBS Wealth Management argue that ‘’sterling looks extremely undervalued on most measures’’.
Although the pound has fallen against the euro, it is up around 8 per cent against the dollar since the start of the year, UBS WM economist Dean Turner noted. “So which indicator is right? Eventually, economic fundamentals assert themselves, and they suggest that the pound’s journey south against the euro is probably closer to the end than the beginning.”
Economic data releases on Wednesday suggest that “the euro area’s recent improved growth performance is set to continue into the second half of the year”, something that “will be welcomed by the ECB”, according to analysts at RBC Capital Markets.
They believe the central bank will announce a further tapering of its bond-buying programme at its meeting next month.