EUR/GBP Outlook: French Fiscal Risks Limit Euro Recovery
French fiscal strains could limit the Euro’s recovery against the Pound, Rabobank says, even as Britain faces a difficult Budget later this month.
Britain’s approaching Budget would ordinarily leave Sterling exposed, but Rabobank believes France’s deeper political and fiscal difficulties are limiting the Euro’s ability to benefit.
The bank’s three-month EUR/GBP forecast of 0.85, set out in its assessment shared on Monday, points to little recovery from Friday’s close near 0.8465.
The Euro ended the week roughly 0.4% below the previous Friday’s close, leaving the revised target just above the market despite Rabobank having lowered its projections.
That allows for some respite after the selling, without requiring a reversal of the concerns that have favoured Sterling.
Rabobank says: “France’s political and fiscal issues are arguably in a more difficult position currently than those of the UK. This has allowed EUR/GBP to push lower ahead of the October 28 UK budget and should cap upside potential for the currency pair.”
The change in emphasis is significant for a bank whose July outlook anticipated a stronger Euro as UK political risks returned.
Britain’s fiscal problems remain, but investors now have more reason to question the alternative across the Channel.
French bond strains reach the currency market
The widening premium investors demand to hold French government bonds over German debt has become more consequential for the Euro.
Rabobank explains: “The past two years have brought very difficult budget negotiations in France. Until recently, the widening of OAT-Bund yield spreads has not had a significant and sustained impact on the value of the EUR. This implies that sellers of French debt were rolling into other Euro denominated paper.”
Selling French bonds to buy German debt can leave money within the same currency.
Concern that fiscal stress could spread beyond France creates a different risk for the Euro if investors start reducing their exposure to the region instead.
The bank says: “It is not just the passage of the budget that is worrying investors but the complications that are implied by next spring’s presidential election.”
Rabobank nevertheless cautions against treating the latest tensions as a repeat of the Eurozone debt or exchange-rate crises: “We would stress that Europe’s circumstances are currently very different from either of these crises and we would be cautious of drawing comparisons.”
There has already been some relief since Monday’s assessment, with French bonds leading a Eurozone rally in early Friday trading.
That recovery illustrates the scope for reversals during the budget debate, even while the underlying financing and political questions remain unresolved.
Britain still has to convince its lenders
Rabobank writes of Chancellor John Healey: “There is a lot for the UK gilts market to worry about headed into the UK’s budget on October 28. PM Burnham has a long wish list, and Chancellor Healey’s fiscal headroom has been eroded, not least by higher debt servicing costs implied by elevated bond yields. Added to this, a loosening in the UK labour market hints at more stretched tax revenue and an increase in welfare spending. Both Burnham and Healey have provided reassurances that former Chancellor Reeves’ fiscal rules will be adhered too. The implication is that taxes are likely to be raised again, though that is neither constructive for the growth outlook nor for voters’ reactions.”
Meeting the rules through higher taxes could reassure lenders about borrowing while weakening demand, leaving the Pound sensitive to both the credibility and the economic cost of the package.
In his subsequent 8 October speech on financial resilience, Bank of England Governor Andrew Bailey stressed that credible fiscal frameworks can help contain the extra compensation investors demand during shocks.
Expectations of tighter monetary policy offer Sterling another source of support, reflected in MUFG’s case for a November BoE increase, but a rise in borrowing costs caused by doubts about government finances is less reassuring for the currency.
Rabobank wrote on Monday: “That said, a lot of these worries are already in the price. CFTC positioning data suggests that speculators have been short of GBP for some time.”
Existing bearish bets may limit the surprise from familiar concerns, but they do not protect Sterling against a Budget that unsettles lenders more than expected.
Rabobank expects turbulence around the event: “There are good reasons to expect that increased volatility will be maintained in EUR/GBP this month. Chancellor Healey faces a difficult task on October 28 but the situation on the other side of the Channel suggests that GBP is less vulnerable to a sell off vs. the EUR than it would be otherwise.”
EUR/GBP Exchange Rate FAQ
What is Rabobank’s EUR/GBP forecast?
Rabobank forecasts 0.85 over three months, equivalent to 85 pence per Euro.
Does that imply a stronger Euro?
Only a modest recovery from Friday’s close near 0.8465. The bank expects French political and fiscal concerns to limit gains.
What could change the outlook?
The UK’s 28 October Budget and progress on France’s budget could shift investors’ assessment of which currency carries greater fiscal risk.
