Pound Sterling’s Advantage Over The Euro Has A Complication

Pound-to-Euro Forecast: French Debt Risk Competes With Softer UK Rate Bets

The British Pound faces competing forces against the Euro as French bond concerns persist, while UK growth and BoE caution pull rate expectations apart.

Pound Sterling‘s appeal as an alternative to the Euro depends on more than France’s budget difficulties.

The British Pound is also exposed to how far investors reconsider their expectations for Bank of England tightening, after chief economist Huw Pill questioned the scale of the increases priced into markets.

GBP/EUR traded near €1.1829 on Thursday afternoon, up 0.09% on the day.

New analysis from UniCredit shows why French bonds remain vulnerable, while Mizuho’s account of Wednesday’s gilt rally illustrates the risk of assuming UK interest-rate support will strengthen indefinitely.

Together, they leave the cross-rate facing a contest between fiscal confidence and prospective returns on Sterling assets.

France’s borrowing premium has become more country-specific

UniCredit puts the gap between ten-year French and German borrowing costs at around 140 basis points in its recent assessment.

The gap measures the additional yield investors demand to hold French debt instead of German Bunds.

Luca Cazzulani, UniCredit’s head of strategy, distinguishes French OATs from Italian BTPs within Europe’s government-bond market: “Higher Bund yields are putting pressure on EGBs but not all spreads are widening for the same reason nor by the same magnitude.

“The divergence between OATs and BTPs suggests that investors have become more selective, placing more weight on domestic factors, a stance that is likely to persist.”

Spain provides a useful comparison with France.

Cazzulani writes: “Spain’s spread ratio is lower in absolute terms, consistent with its stronger credit profile, and remained unfazed by recent calls for early elections. Furthermore, its trajectory mirrors that of Italy.

“This suggests that BTPs and SPGBs have largely been driven by common factors, whereas the French market has followed a distinct path.”

“The picture is different for France, where the increase in the spread ratio points to country-specific issues being at play and a deterioration in market perception.

“OATs should be trading with a spread to Bunds 50bp below the current market level to have a spread ratio in line with early September levels.” Cazzulani writes.

That calculation is a measure of how far the premium has increased relative to the interest-rate environment, not a forecast that French spreads will narrow by 50 basis points.

The political obstacle is persistent.

Cazzulani says: “Investor concerns stem from France’s need to reduce its fiscal deficit in order to slow, and ultimately stabilise, the rise in public debt.

“The required adjustment is politically challenging.

“Meaningful fiscal consolidation is unlikely before the presidential election, which is still six months away, and may remain difficult even thereafter.”

French bond weakness can weigh on the Euro if investors reduce their exposure to the currency, but it need not do so when money simply moves into German or other Euro-denominated assets.

That qualification prevents a widening French spread from becoming an automatic forecast of further Pound gains.

The relative fiscal argument featured in our earlier examination of Rabobank’s Euro-Pound outlook, which also acknowledged Britain’s own Budget risks.

UK growth complicates a retreat in rate expectations

Pill’s comments offered a separate reason for UK bond yields to fall, even while French debt remained under pressure.

Mizuho strategist Evelyne Gomez-Liechti writes: “Gilts outperformed as the session’s initial dovish impulse from BoE Chief Economist Huw Pill proved more durable than the subsequent US CPI shock.”

“Pill questioned the four hikes priced over the coming year, driving an 8.5bp rally in late-27/early-28 SONIA and pulling short-dated Gilts lower in yield, with the move transmitting across the curve and producing early bull steepening.”

Her account concerns Wednesday’s market response, before Thursday’s GDP figures showed 0.1% growth in August and a 0.7% expansion over three months.

The stronger activity picture makes it harder to argue that the Bank must avoid tightening solely because the economy is weak, as our UK growth reaction explains.

But support for a November increase does not settle whether four rises are necessary over the following year.

The Bank’s September decision left rates at 3.75%, with three policymakers preferring an increase.

Our house view is that stronger growth can protect Sterling’s rate support while leaving it vulnerable to a reduction in the amount of tightening priced further ahead.

Meanwhile, UniCredit sees no easy near-term solution for France.

Cazzulani warns: “Another source of vulnerability is the high share of foreign ownership of French government debt, as foreign investors tend to react quickly to adverse news.

“Although the ECB’s Transmission Protection Instrument (TPI) should limit the risk of extreme spread widening, the intervention threshold is likely to be well above current market levels.”

GBP/EUR Exchange Rate FAQ

Why can French debt concerns help the Pound against the Euro?

They can reduce confidence in Euro assets, although money may stay within the Eurozone.

Did Huw Pill rule out a November rate rise?

His challenge concerned the scale of market-priced tightening, rather than a definitive November decision.

Is there a new GBP/EUR exchange rate target?

This is a cross-rate assessment of competing bond and policy risks, rather than a numerical target.