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Pound Sterling suffering "growing pains", says Crédit Agricole.
Analysts at a leading global investment bank say the British Pound will need good news to correct a growing undervaluation against the Euro.
Crédit Agricole says the British Pound is suffering "growing pains" from a series of successive data disappointments, but the recent selloff against the Euro might have already stretched too far.
In a recent analysis, Crédit Agricole analyst Valentin Marinov says the Pound is now one of the worst-performing G10 currencies so far in July.
He explains that the reasons for recent losses rest with increasing investors' focus on the recently failed UK welfare reforms, which means that Keir Starmer's government will need to hike taxes in the autumn.
Marinov, who is CA's Head of G10 FX Strategy, also says a run of UK data disappointments has prompted markets to expect a more aggressive run of interest rate cuts at the Bank of England this year and next.
"This made the GBP particularly vulnerable during the latest bout of USD consolidation across the board. The contrast between the dovish BoE outlook and the more neutral ECB rates outlook has further added to the tailwinds for EUR/GBP," says Marinov.
Although the Bank of England might increase the pace it cuts, the European Central Bank (ECB) will likely cut just once more, in September, creating the prospect for deeper falls in UK interest rates relative to those in the Eurozone. This typically would be expected to weigh on Pound Sterling against the Euro.
In line with this adjustment in expectations, the Euro-Pound exchange rate rose 1.75% in June and is already up a further per cent in July at 0.8665. This means the Pound to Euro exchange rate has declined to 1.1540, and our Week Ahead Forecast suggests 1.15 will be tested shortly.
Analysis by Crédit Agricole finds that "it would take positive data surprises today to help the GBP regain some of its composure in the very near term."
Above: GBP/EUR at daily intervals showing strong downside momentum (via RSI in lower panel). Also shows sketches made in our Week Ahead Forecasts since June.
The first test for the pair will be on Wednesday, when the UK releases inflation data for June. Thursday's labour market figures will also be an important moment for Pound Sterling, as the outcome will inform Bank of England policy makers of whether there is a need to speed up the pace it cuts interest rates.
The market has moved a long way to account for additional rate cuts: it now sees two cuts as a dead certainty, with a third cut now seen as a potential outcome.
However, Marinov thinks that Pound's adjustment against the Euro leaves it looking better valued:
"The currency could remain quite vulnerable to potential disappointments that could add conviction to the market’s dovish BoE outlook. That being said, we also note that some negatives are already in the price and the GBP is looking undervalued vs the EUR, albeit not vs the USD."
With sentiment towards Pound Sterling already subdued, the potential for a recovery grows into upcoming data releases as the bar is already set very low.
To put it simply, the bigger surprise would be if data beats expectations, meaning there is a bigger chance of a relief rally than a material selloff in GBP/EUR.