If there is one firm that would know what the arrival of a Goldmanite at the head of the BOE means for the GBP, and specifically EURGBP, it would be Goldman. Moments ago Goldman's Tom Stolper just poured more gas into the EURGBP "parity" fire, sending the EUR spiking. That said, the logical Stolper-contrarians in us say this is precisely the time to fade the relentless move higher in the EURGBP: history is on our side about 93% of the time. After all, Goldman's prop flow desk is now selling the pair to its clients. This is even as we said to short the GBP with both hands and feet in late November when Carney's appointment was announced: a move that has resulted in nearly a +1400 pip gain in the GBPUSD short. Oh well, time to take profits.
Go long EUR/GBP on monetary policy and current account differentials
We have long held the view that Sterling is likely to weaken relative to the Euro. The key drivers of recent Sterling weakness remain in place:
While the Bank of England will likely continue to ease monetary policy, in particular under next Governor Carney, the ECB appears to be firmly on hold and shrinking passively its balance sheet.
- Notably higher inflation rates in the UK than in the Euro area could gradually further erode the UK's competitiveness.
- As discussed in Monday’s Global Markets Daily, expectations of monetary easing by the Bank of England have driven inflation expectations higher. As a result, real interest rate differentials have widened to levels consistent with EUR/GBP closer to 0.90 on a historical comparison.
- As Euro area-related risk premia decline, the safe haven flows that boosted the Pound vis-à-vis the Euro have reversed. In our view, this has been the main driver of the EUR/GBP move so far. Despite some Italy-related risk currently, we think this trend will persist.
- The trade and current account balances of the Euro area are now in far better shape than in the UK. While the Euro area records current account surpluses in the 1% of GDP area, the UK’s current account has shown volatile deficits in the 3% area.
- The ongoing political debate about the benefits of EU membership could weaken the prospects for long-term investment inflows into the UK.
- Option markets and IMM data suggest speculative short GBP positioning remains close to neutral.
On balance, all these factors suggest that the weak Sterling trend will continue despite a sizable move already. In terms of risks to this view, we would emphasise the renewed escalation of the Euro area crisis, clear evidence of external rebalancing in the UK or indications that the BoE may not ease further.
We would go long EUR/GBP with a stop on a close below 85.70 for an initial target of 91.00. We think the weak Sterling trend will continue, in particular on the back of continued monetary policy easing in the UK.