- GBP/EUR uptrend to test above 1.19 next
- But, EU-UK reset could disappoint
- Global sentiment to remain key for GBP
- Meaning concerns over U.S. debt dynamics a key risk
Above: Prime Minister Starmer has been meeting European leaders over the course of the past two weeks with an eye to a deal. Picture by Lauren Hurley / No 10 Downing Street.
Pound Sterling is consolidating ahead of a potential push higher.
An immediate catalyst to further GBP gains against EUR would be a positive outcome to EU-UK talks, due to be announced next week.
The UK and EU are hoping to agree deals on security, youth mobility and trade, with analysts saying progress is behind some of the recent gains in the Pound.
"The gradual post-Brexit rapprochement between the UK and the EU continues and could, over time, alleviate some of the negative consequences for the former, in a boost to the GBP," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.
However, we would be cautious of disappointment on this front at some point early next week, based on the press reports we are reading.
"Officials now expect that the only big agreement out of Monday's meeting will be a relatively uncontroversial defence and security pact," says a report in Politico.
Some potential red lines that could scupper a more comprehensive agreement include the issue of fisheries and free movement of youth under 30, particularly given the UK's acute immigration crisis that Starmer has promised to solve.
"We will not be pushed around," said a senior UK government figure on whether or not the UK would ultimately capitulate to EU demands on fish and free movement.
A tepid deal focused solely on defence would be disappointing to a market hoping for more and could spark a retreat in the Pound to Euro exchange rate (GBP/EUR) below 1.19 and towards the lower 1.18s again.
Above: GBP/EUR at daily intervals.
The EU-UK deal is the main point of interest to focus on in the near term, but the bigger trend will ultimately rely on ongoing improvements in global investor sentiment, and improvements here continue to suggest GBP weakness will be limited.
Pound-Euro has a high correlation with equity market volatility, falling sharply in April when volatility spiked in the wake of Donald Trump's April 02 Liberation Day tariff announcements.
The story since mid-April has been one of cooling tensions and fading volatility, allowing GBP/EUR to 'melt up'.
However, there are some analysts who think the good news is now in the price after China and the U.S. reached a temporary accord with a view to reaching an agreement that sees tariffs materially lowered from April 02 levels.
Above: EUR/GBP (top) falls - i.e. GBP strengthens - as U.S. equity market volatility fades as trade tensions ease.
Uncertainty around trade policy and the volatility in potential rules remain, and the absence of clarity further amplifies a cautious approach for consumers, producers, and investors.
"Risks remain, and other tariff actions are likely to keep inflation at uncomfortably high levels for the Fed. Our base case remains that the next rate cut will not be until December," says Justin Weidner, Economist at Deutsche Bank.
This could disappoint investors who have been hoping for Federal Reserve rate cuts to stimulate the economy.
With the market rudderless and looking for fresh good news, the prospect of softening sentiment grows, which would favour the Euro.
Above: House Speaker Johnson (right) is to push through new spending plans that will grow the U.S. debt burden. DOD photo by U.S. Navy Petty Officer 1st Class Alexander Kubitza.
Also, keep an eye on the U.S. fiscal front, where politicians are trying to get a new spending bill through Congress.
Republicans look to be planning a $4 trillion debt ceiling increase as part of a U.S. budget reconciliation bill, and economists think it could put the U.S. on course for a fiscal deficit of 6.5% of GDP in the coming years.
The risk is that foreign investors will struggle to absorb the huge supply of debt (bonds) required to fund this spending deficit. If this is the case, then negative financial market developments would ensue, scuppering investor sentiment.
"Can the US Treasury market continue to absorb increased supply and apparent indifference to rising deficits by the Trump administration? Much of the cost of this bill is merely to extend the status quo and other aspects could easily be crowded out by yields being higher than otherwise would be. That in our view means this development will not prove positive for the dollar," says a note from MUFG, the global investment bank.
Given the Pound's strong correlation with sentiment, any concerns about U.S. debt that spill into wider markets could well lead to a lower GBP/EUR.
For now, it is a downside risk we are watching, and the preference is for the current equity market rally to extend as investors take account of incoming data that continues to show the world's largest economy is not at risk of recession.
Given this, the path of least resistance for GBP/EUR in the near term is higher, with a break of 1.19 preferred.