- Nomura reopens long EUR/GBP targeting 0.8750
- Morgan Stanley sees GBP lagging EUR despite carry advantage
- Barclays sees limited GBP upside
File image of Chancellor Rachel Reeves. Picture by Kirsty O'Connor / Treasury.
The Pound's star is waning amidst building debt concerns and a deteriorating economy.
Pound Sterling is entering a critical juncture against the Euro as diverging policy outlooks, fiscal sustainability concerns, and softer domestic data narrow the room for sterling outperformance.
This is according to a number of investment bank analysts we follow, who see a growing asymmetry in risks facing the Pound, amid ongoing positive sentiment towards the Euro.
Nomura has reopened a long EUR/GBP position (a bet on a GBP/EUR decline), arguing that structural and cyclical pressures on the pound are beginning to mount.
The UK's fiscal outlook is a key concern: while the government’s spending review, due today, may lack major headline measures, it is expected to underscore the persistent challenge of deteriorating national finances, a vulnerability Nomura sees persisting through to the next budget cycle in late October.
The Bank of England's hawkish tone is also expected to fade. April inflation was revised lower, and expectations in both wages and prices have softened, according to the Bank’s own surveys.
Tuesday's market data reinforced this trend; the PAYE measure of employment showed a 109K drop in employment in May alone, the biggest drop since the Covid crisis.
Image courtesy of @julianHjessop
Following the disappointing jobs report, the market raised expectations for an August interest rate cut, whereas it held 50/50 odds of such an eventuality ahead of the report.
In new research, Morgan Stanley says Pound Sterling benefits from a favourable carry-to-volatility profile and a perceived buffer against trade tensions, which should mean it outperforms the Dollar and other currencies.
However, foreign exchange analysts at the Wall Street bank think the Pound will trail the Euro and Yen through the coming months.
It warns investors are wary of a potential breakdown in the GBP-gilt correlation, particularly if bond markets globally begin pricing in deeper fiscal concerns.
Morgan Stanley says should long-term gilt yields climb as markets scrutinise the UK's debt trajectory, the appeal of holding sterling, even with its yield advantage, could quickly fade.
Above: Bond yields and the Pound last diverged in January, when markets worried that the UK economy would struggle under Rachel Reeves' taxes.
"As we saw in January and in other periods before, there can be an unexpected emergence of a 'tipping point' where the GBP-gilt correlation flips from positive to negative and where risk premium could prove problematic," says David S. Adams, a currency researcher at Morgan Stanley.
Against this backdrop, Morgan Stanley sees room for EUR/GBP to continue climbing toward the upper end of its medium-term range, possibly as high as 0.90. (Pound-to-Euro down to 1.11).
Barclays: Some Room for GBP Upside, But Limited
Barclays strikes a more balanced tone, acknowledging that the recent stabilisation in risk sentiment has pushed the pound closer to levels justified by rate differentials and volatility measures.
Still, analysts at the UK bank see only modest further GBP/EUR upside, likely topping out in the 1.2050-1.19 range.
Recent developments in UK trade policy, including progress on steel and aluminium tariff carve-outs and ongoing negotiations with both the EU and the U.S., support a constructive view on the pound.
However, Barclays remains cautious about overstating the strength of the rebound given structural macro headwinds.