Analysts have been slashing their sterling/euro forecasts since the UK voted to leave the EU at the end of June and some are predicting parity.
But Bank of America Merrill Lynch says that, although the pound should keep sliding against the dollar, it should hold firm against the single currency from here.
The pound has skidded 25 per cent against the euro since the end of 2015, hitting a three-year low of 87 pence per euro earlier this month, writes Joel Lewin.
With the UK’s economic health and future relationship with the EU shrouded in uncertainty, analyst forecasts for where euro/sterling will head from here have sprawled in different directions.
The spread between the highest and lowest euro/sterling forecasts has surged from 0.12 points before the referendum to 0.26 points in August, according to BAML.
They now range from 70p-96p per euro.
BAML expects the pound will slip a further 5 per cent against the dollar to $1.25. However, against the euro it expects it to hold firm and suggests predictions of parity are unlikely to ever be realised.
“We do not see the kind of divergences that would suggest that a move toward parity is imminent,” BAML strategists, lead by Kamal Sharma note.
The spread between gilt yields and the average eurozone yield plunged from 1.37 percentage points in April to 0.6 percentage points in August, a key driver of the plunge in the pound against the euro.
But since then it has eased back to 0.74 percentage points and is unlikely to narrow further since the Bank of England is reluctant to cut rates into negative territory, like the European Central bank has.
BAML notes “the move in EUR/GBP now looks overextended versus rate differentials in a similar way that it did in 2008,” as you can see in the chart.
The decision by the Bank of England to reintroduce Quantitative Easing (QE) now brings monetary policy closer into line with that of ECB and with the Bank of England reluctant to move rates into negative territory, rate spreads versus the ECB should remain relatively stable, in our view
The strategists say that investors switching out of low yielding eurozone bonds into higher yielding gilts helped drive the pound to multi-year highs against the euro in 2015.
With the ECB already conducting its own QE program, we doubt the reintroduction of QE in the UK would lead to an allocation shift out of gilts and into European bonds. An asset allocation out of gilts and into US Treasuries is a more obvious reallocation with the accompanying FX implication of a weaker GBP/USD.
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