The Pound to Euro exchange rate hit a new two-and-a-half-year low last week in reaction to dovish comments from Bank of England Governor Mark Carney.
‘Brexit’ Fallout Hurts Sterling
GBP/EUR weakened by around three cents to 1.20 at the start of last week’s session as investors struggled to come to terms with the far-reaching consequences of Britons’ decision to vote to leave the European Union. Uncertainty surrounding when the UK will leave the bloc, what kind of new trade deal will be agreed and who will lead the country through the negotiation process weighed heavily on Sterling. As did concerns regarding a potential second independence referendum in Scotland and the possibility of Northern Island reuniting with the Republic.
However, profit-taking kicked in on Tuesday and Sterling reached a weekly high just below 1.22 on Wednesday as a so-called ‘Brelief’ rally took place despite warnings of recession. All three major ratings agencies downgraded UK debt and multiple economic analyst groups released ‘Brexit’-adjusted forecasts suggesting the UK would slide back into recession in the next 12-18 months.
‘Brelief’ Rally Doesn’t Last Long
The counter-intuitive Sterling rallies faded away on Thursday and GBP/EUR resumed its downtrend. Bank of England Governor Mark Carney announced that ‘some monetary policy easing would likely be required over the summer’ in response to the ‘Brexit’ vote and this kicked off another round of Sterling selling.
GBP/EUR hit another two-and-a-half-year low below 1.20 on Friday as UK government debt yields dropped to record lows. Investors have been piling into British Gilts, despite the ultra-low profit margins, because they see other investments as being too risky during this period of intense volatility. This has depressed the yields on UK bonds and subsequently reduced the appeal of the Pound.
Where Next For GBP/EUR?
Although the Pound has settled somewhat in the 10 days following the historic ‘Brexit’ vote, there is still every chance that Sterling will weaken further in the weeks ahead. The BoE looks set to begin slashing interest rates again in the near future and, most likely, resume its QE bond-buying programme. This new leg of stimulus will likely continue to drive down UK government bond yields, which in turn will weigh on investor demand for the Pound.
This week’s horrendous seven-year low UK construction PMI result could be a sign of things to come and it is possible that we could see Sterling slide lower as economic confidence falters. The BoE is set to release new projections on Tuesday morning and this could be the catalyst for another devaluation of the Pound if analysts are unsettled by the central bank’s ‘Brexit’-adjusted outlook.