Date: 05 Sep 2017

A commentary piece from Reuters on Friday argued that neither the Bank of England (BOE) nor the European Central Bank (ECB) would likely want to see euro/sterling (EURGBP) trading at parity, a prospect that has been mooted in some sections of the media in recent weeks. As the Reuters commentary piece pointed out a yet stronger euro would merely make it harder for the ECB to achieve its inflation goals while a yet weaker sterling would only give the BOE an additional headache as it would push UK inflation up further. But proponents of a move in EURGBP towards parity could legitimately argue that there’s not much the BOE or the ECB could actually do about it if the market decided to push the cross higher. In the absence of physical intervention in the currency markets (and the BOE hasn’t intervened to support the pound in the forex market since the ERM crisis of 1992),  the ECB and BOE could opt for jawboning but that wouldn’t necessarily come with any guarantee of success. In reality EURGBP’s fate lies with the market and that will be based on a hard-nosed evaluation of the situation. Dutch Bank ING, for one, thinks that parity is a step too far for EURGBP, at least in the next three to six months, and that, by their reckoning, “EURGBP is rich by a staggering 20 per cent based on [their] medium term Behavioural Equilibrium Exchange Rate valuation framework” and that “when the medium-term valuation reaches such extreme levels, it tends to be difficult for the currency to weaken materially given the limits imposed by the underlying fundamentals.” In addition, ING feels that for momentum towards parity to be sustained, the currency market would have to become even more convinced that the United Kingdom would make a “hard Brexit” and the Dutch bank feels that political will on both the British and EU sides will eventually mean that prospect fades.

Others might disagree with that but it’s hard to argue with the point that historically GBP is already very weak versus the EUR. ING also makes the point that as Cable (GBPUSD) isn’t exhibiting “visible signs of a UK-specific risk premium,” with “both UK and US political uncertainty offsetting each other in the near-term, making the euro the go-to “political haven in currency markets.” By that token the high level of EURGBP is as much a function of euro strength as it is sterling weakness. That begs a simple question for those who do see a possibility of EURGBP reaching parity. If the pound continues to hold its own versus the US dollar, that means the EURUSD would have to soar for EURGBP to reach one-to-one.

Written by Neal Kimberley, External Currency Analyst.