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Since the European Union referendum in June 2016, EUR/GBP has been caught in ‘no man’s land’ trading within the 0.84-0.88 range most of the time. As such, we do not see the upcoming UK general election as a major game changer for the GBP. However, as the probability distribution of Brexit outcomes is likely to be affected by the election result, it has implications for the overall risk assessment of the sterling.
The biggest risk factor for EUR/GBP in the coming month is related to the ECB meeting on June 8 (same day as the UK general election). The market’s rate hike expectations are relatively subdued, indicating that this is still a theme that could develop. If markets start to re-price the ECB in a more hawkish direction, it would potentially push EUR/GBP higher. However, EUR-crosses would be more sensitive to a signal on rates than to a possible extension of QE, and therefore, it seems premature to discuss ECB rate hikes, Danske Bank reported.
The domestic outlook in the UK does not provide much relief for the GBP in the coming year: growth will slow, as real wage growth has turned negative implying less scope for private consumption growth. The market is pricing in a full 10 basis points hike in 12 months’ time, which, given the economic outlook, seems overdone. Hence, both relative growth and relative monetary policy do not imply any substantial downside potential for EUR/GBP in the short to medium term.
Further, any turning point for GBP would eventually have to be driven by reduced uncertainty about the future agreement between the UK and the EU, which could entice foreign investors back to Britain amid attractive valuations on UK assets and the GBP. This could potentially take EUR/GBP down towards or below its fundamental equilibrium in coming years.
"In the status quo scenario, we expect EUR/GBP to remain in the 0.84-0.88 range in the coming year. In this scenario, we still see a sizeable risk that the Brexit negations derail at some point, which justifies a weaker GBP relative to our main scenario," the report commented.
