GOLDMAN: The British pound might not be the only victim in post-Brexit Europe

The pound has received the brunt of the pain after the UK voted to leave the EU in June.

The British currency collapsed by over 11% in the immediate aftermath, and continued trickling down in the days after. Most recently, it hit another fresh 31-year low of 1.2798 in overnight trade.

But the pound might not be the only victim in post-Brexit Europe.

In a recent note to clients, Goldman Sachs’ Silvia Ardagna, Robin Brooks, and Michael Cahill argued that political risk is underpriced in the euro.

“… the UK referendum can have political implications for the Euro area. So far, the market has treated the UK Leave vote as a local shock with global consequences only for bonds. Owning to the rise in support for anti-EU parties across Europe, the political risk of a less cohesive Euro area is another reason to remain bearish EUR,” the analysts argued.

They note that although the euro has been considered to be a somewhat safe-haven currency as of late, that’s only been the case when economic/political problems didn’t start in the euro area.

In fact, the euro fell in the 2012-2013 sovereign crisis, and also, more recently, ahead of European elections, the team added.

As such, “in coming weeks, the re-do in Austria’s elections or developments in the Italian banking system are events that could put further downward pressure on the EUR,” they suggested.

However, not everyone shares t
he Goldman trio’s forecast.
In a separate note to clients, a UBS team led by strategist Daniel Waldman suggested that if European economic growth stays in line with forecasts, the euro might not weaken against the dollar.

Here’s what they wrote (emphasis ours):

“Although markets are likely to stay attuned to political developments, negative “news” has become a smaller driver of EUR/USD in recent years. Rather, we expect growth differentials to be key. Following the Leave vote, our European economists lowered their growth forecasts for 2016 to 2017. If Euro area growth can remain near their 2016 forecast of 1.5%, we think EUR/USD should remain supported. […]

The Leave vote has increased risks for the euro, but favourable valuation, and growth re-synchronisation between the US and Euro area, should drive EUR/USD higher over the medium term. Over a longer time horizon, we expect EUR/USD to continue rising toward fair value, which we see as being around 1.25. This should be very gradual, however, and our forecast for end-2017 is only 1.20.”

Putting those two things together, some analysts think that a shaky political situation in Europe would be a bearish sign for the euro, while others think that economic growth that’s in line with expectations could be a bullish sign.

Or, of course, something else entirely could happen, too.

Still, for what it’s worth, although the Goldman and the UBS teams have pretty different forecasts, both teams capture the idea that currency markets reflect the sentiments of investors.

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