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The pound has been an easy target for currency markets as the combination of a post-Brexit economic reality check and ongoing political anxiety has made the UK economy an outlier relative to its faster growing European peers. In fact, GBP is beginning to show signs of idiosyncratic selling, similar to previous periods when domestic political risks have flared up.
The euro has become a 'political haven' for currency markets. The ongoing global politics suggests a Brexit disaster can be avoided. For GBP's politically-driven weakness to persist and extend all the way towards parity against the EUR, we would argue that 'hard Brexit' risks would need to notch up another gear. In reality, the only way this could occur over the next six months is if we get a nightmare Brexit scenario in October - that is a complete breakdown of UK-EU negotiations.
Markets have adjusted to a wait-and-see BoE stance. The latest round of key UK economic data has put talks of a BoE rate hike on the back burner, with the breakdown of 2Q GDP highlighting the current weakness of the UK consumer. However, markets have now adjusted to a wait-and-see BoE policy stance and see limited risks of a flatter UK rate curve. For short-term domestic rates to move lower, we would need to see evidence of weak consumer activity turning into a hard-landing for the UK economy. Economists see this as highly unlikely and are not expecting the economy to take a significant turn for the worst.
The ING Bank also believes EUR/GBP parity may not be in the economic interests of the BoE given the implications that further GBP weakness has for imported inflation and the squeeze in real household incomes story. Equally, one could argue it is not in the economic interests of the ECB for financial markets to get ahead of themselves when it comes to pricing in the end of the central bank's quantitative easing programme. With implicit opposition from both sides, it's difficult to fundamentally justify any EUR/GBP move towards parity - certainly over the next three to six months.
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