Pound to Euro Exchange Rate Supported at 1.22 as Mark Carney Soothes Market Fears

 Saturday, 25 June 2016 09:33

By Will Peters
willpeters@poundsterlinglive.com

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The GBP to EUR exchange rate appears to have found tentative support above 1.22 but remains highly volatile.

It is official, the UK has voted to leave Europe, now the questions on sterling's future begin to be asked.

Sterling was seen sharply lower across the board following what was always going to be a close result according to the polls.

The problem is markets tacked onto the betting markets for guidance. Where polls were showing a 50/50 split bookies were often showing a +70% chance that the UK would vote to remain.

The markets backed the wrong horse.

Therefore, the GBP was far too high heading into results night.

We have seen whopping losses against the safe haven yen, dollar and Swiss franc - traditional safe haven currencies.

The euro is however also seen prone to downside risks as it is argued the Eurozone has much to lose from Britain's departure.

Therefore, the losses in the pound to euro exchange rate are notably less severe.

GBP/EUR touched 1.20 in the aftermath of the vote but managed to recover back to above 1.23.

Action on the hourly charts suggests 1.22-1.24 is emerging as an initial post-brexit range:

Bank of England Offers Comfort

Sterling, and the broader financial markets for that matter, took a positive from the appearance of theBank of England's Governor Mark Carney following the resignation of Prime Minister David Cameron.

Carney delivered a statement from the Bank of England with an assured demeanour that surely convinced traders the sky was not falling in on them.

Carney noted some market and economic volatility can be expected as this process unfolds.

"But we are well prepared for this. The Treasury and the Bank of England have engaged in extensive contingency planning and the Chancellor and I have been in close contact, including through the night and this morning," said Carney.

The Bank has more than £250BN worth of funds it can make available to markets, should they get into distress.

Distress is itself unlikely as Carney points out the UK banking have capital buffers that are ten times stronger than they were back in 2008.

We would expect sterling to remain supported from here.

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The Outlook: Parity or 1.44?

It is worth remembering what Nick Parsons at NAB said ahead of the referendum - essentially he argued the pound would recover sharply against the euro and move above 1.40 within days of a Brexit.

Why? Because the euro arguably has more to lose from a UK exit. Will the bounce happen?

Then again, maybe UBS will be right - they argue the pound could fall to parity against the euro as the UK's current account deficit is brought into sharp focus.

Basically, the UK imports more than it exports and relies heavily and the pound relies on foreign investment flows to sustain the levels it has over recent years.

Now those inflows could be at risk, therefore, GBP/EUR could hit 1:1.

A Cruel Reversal

Sterling had an impressive day on Thursday, pushing towards 1.31 as betting markets were seeing a 90% chance of the UK voting to remain in the European Union.

It looks like the call was correct when at 22:00 a YouGov Call Back poll showed Remain had won the day with 52%.

The pound to euro exchange rate (GBP/EUR) rallied to test its best levels of the day on the news.

However, that is about as good as it got for the pound which soon had some real vote results to contend with.

Newcastle-upon-Tyne raised a few eyebrows by delivering a slim Remain victory, the margin was supposed to be bigger.

It was when Sunderland handed a landslie 61% to Leave that the sell buttons were pressed.

GBP plummeted and gave up weeks of gains within minutes.

The only certainty as we move through the early hours of the morning is that sterling will continue to trade in volatile fashion as the results trickle in.

The Thursday Rally was Premature

The rally higher came on the back of a sharp rise in odds of the UK remaining in Europe, with some reports of some bookies seeing a 90% chance of such an outcome.

The move was driven by the final poll from Ipsos Mori which served to confirm voters were leaning towards Remain.

However, the poll of polls remained at 51% for Remain, 49% for Leave.

We found the surge bizzare and were wary about chasing the move higher.

“GBP/USD fell 200 points from its high to 1.4750 as traders took profits on the earlier rally, positioning themselves cautiously ahead of a still uncertain outcome," says Andy Scott at HiFX, the foreign exchange brokerage.

Leading into this evening Scott expected liquidity to fall further as banks reigned in FX activity, especially in GBP transactions with no one wanting to get their fingers burnt by the expected big moves that are possible in either direction.

"We expect some initial reaction in Sterling to the exit polls after 10pm, with the main excitement likely to be in the early hours of Friday morning once we starting getting the results in," says Scott.

We Suspected the Odds Markets Were Dangerously Optimistic

An interesting point was made by Adam Jepsen at Financial Spreads concerning the odds markets and sterling's rally on account of odds that saw a +70% chance of the Remain vote winning:

"One high street bookmaker has already said the average bet size on Remain is about 5 times bigger than those on Leave. That would certainly skew the odds.

"Importantly, the bookmaker also said 62% of bets were on Leave.

"The headline odds say one thing, the number of individual bets say another."

Indeed, if this is the case then we would be nervous of chasing sterling too high.

Pound Had Climbed Back to Fair Value

The move towards Remain saw a short-covering rally take place; i.e. investors were closing out of their negative bets.

“With implied betting probabilities of an exit having dipped below 15% we have seen GBP USD take out the 1.49 level for the first time this year. If we see a move back towards 1.50/51 we may start to see investors seeing some value in fresh shorts as the rally looks increasingly fully valued,” says Jeremy Stretch at CIBC Markets.

Stretch does remind us that of course the polls are merely just polls.

Evidence from recent UK election underlines that their reliability is sometimes questionable.

“Consequently assuming that the late swing towards Remain suggests the event risk has totally dissipated could still be rather dangerous,” says Stretch.

So while sterling is rallying strongly there is a sense that there could be a rude surprise if Brexit does happen.

In fact, unless Brexit happens Thursday night / Friday morning risks being rather boring.