- The euro will not hit parity with the pound, Pantheon Macroeconomics forecasts.
- Eurozone growth prospects, which have driven the currency higher, are overblown.
- The UK government’s likely move toward a more conciliatory Brexit stance will strengthen the pound.
LONDON — The pound will not drop to parity with the euro, regardless of the political solution in the UK, because prospects for growth of the eurozone economy have been exaggerated, according to the latest research from Pantheon Macroeconomics.
Writing in a note circulated to clients on Tuesday morning, Pantheon’s Chief UK Economist Samuel Tombs said there is “excessive optimism about the Eurozone’s growth outlook.”
The euro has been on a huge tear during 2017, particularly against the dollar, as investors take note of the improving fortunes of the bloc’s economy, which has seen growth recover to its best levels since the eurozone debt crisis. On the flipside, as Tombs notes, the pound has dropped sharply against the single currency in recent months, hitting lows not seen since 2010.
“The main driver of the depreciation,” Tombs writes “has been a huge shift in sentiment in favour of the Eurozone, as the region’s recovery finally has gathered pace. Eurozone GDP rose by 0.5% and 0.6% quarter on-quarter in Q1 and Q2, respectively, virtually guaranteeing that year-over-year growth will exceed 2% this year for the first time since 2010.
This won’t last, Tombs and his eurozone-focused colleague Claus Vistesen said because of the region’s weak productivity and demographic issues.
“Trend growth in the Eurozone probably now is only just above 1%, due to its poor demographics and weak productivity growth. Hopes that long-overdue structural reforms required to raise trend growth will soon be implemented, because centrists parties have prevailed in elections this year, probably have gone too far.”
While the eurozone’s strengthening will come to a halt, Pantheon also made the argument that the pound has likely seen the worst of its drop as the government is likely to continue towards a more concilliatory Brexit stance.
People are now more concerned about the economic realities of Brexit than they are about immigration, something which Tombs believes will allow Prime Minister Theresa May and her government to soften.
Here’s the chart:
One factor that has been cited as a possible driver for further sterling weakness is the collapse of Theresa May’s incredibly weak government. May’s slender parliamentary majority means only a handful of hardline Brexiteers would need to rebel against her on any given issue to cause a disastrous government collapse.
That would likely see Jeremy Corbyn’s Labour Party to sweep into government, a scenario that many suggested prior to June’s shock election result could crash the pound again. Tombs disagrees, noting that “Labour has taken a ‘softer’ stance on Brexit than the Conservatives and the looser fiscal stance it proposes would strengthen the case for raising interest rates.”
Therefore, Tombs argues, the most likely outcome going forward is not euro-pound parity as analysts from the likes of Morgan Stanley have forecast, but rather a strengthening of the pound.
“Accordingly, we think that sterling still stands to make up some lost ground against the euro over the medium term. We see it recovering to about €1.23 by the end of 2018 and €1.27 by the end of 2019,” he concludes.
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