Barclays Says GBP, EUR Sell-Off is Overdone

Barclays Says GBP, EUR Sell-Off is Overdone

 Published: March 2nd, 2022

A major UK lender and global investment bank says the Euro and British Pound look oversold compared to the greenback, and both could see a recovery if investor worries about the fallout of the Russia-Ukraine conflict start to fade.

Both GBP and EUR joined stock markets in mounting a recovery on 28th February when negotiators from Ukraine and Russia concluded talks on the Ukraine-Belarus border, a meeting which ended with a commitment to hold more talks.

Any hope that the war might be resolved would give support to risk-associated currencies and equities.

Forex analysts at Barclays have found that sterling has struggled since Russia invaded its southwestern neighbour last week, however they believe there is "notable" potential for recovery if market fears dissipate.

In a report summarising the research, Barclays said that the sell-off seen in recent days was ‘proportionally bigger for EUR, GBP, INR and TRY, suggesting that oil importers were more sharply impacted.’

The Euro and Pound are two currencies especially exposed to higher oil prices pushed up by supply-side shocks, the report adds.

Crude oil prices crossed the USD 100 per barrel (pb) the week of 21st February as fears grew about the potential loss of Russian oil supplies.

Prices at fuel stations across the UK and Europe also hit record levels on Sunday 27th February, according to Britain’s RAC motoring club.

Investors are forward focused by nature and often price-in worst-case scenarios in advance, meaning and 'peak fear’ could soon pass by, especially if there is evidence that bilateral talks between the two combatants are leading to a resolution.

‘Taken together, our analysis points to moves in EUR, GBP and CEE FX generally being over cautious.’

'Even as the Pound has depreciated significantly due to the conflict, it has a lot of room to climb back as markets increasingly see this conflict as localised. Global risk sentiment is already showing signs of a rebound.’

Keeping a close eye on crude prices

Barclays research also suggests that it might require a period of stable oil prices before a recovery take shape; something no major investment bank is expecting anytime soon.

In a research note, currency strategists at RBC Capital Markets said they believe oil prices are in the middle of a ‘supercycle’, supported by strong fundamentals that point to future price rises.

'Geopolitical crises can prime the pump for a emerging bull market, but ultimately the big market moves will be driven by fundamentals.’

‘With global inflation set to continue rising in the aftermath of COVID-19, we believe there is room for oil prices to keep rising towards the USD 150–170 per barrel range.'

For Sterling, reactions by the Bank of England to recent events will continue to be a major driver.

Barclays says the pound is continuing to attract underlying support from expectations that Threadneedle Street will raise rates for a third consecutive time on 17th March. While economic consensus suggests the Russia-Ukraine conflict brings upside risks for inflation, with central banks expected to raise interest rates in response.

‘The likelihood of higher inflation will raise the BoE’s worry that a wage-price spiral is developing,’ Nigel Godwin, an Economist at Oxford Economics told Bloomberg. ‘The main impact of Russia’s invasion of Ukraine on the British economy will be energy prices that remain higher for longer.’

Godwin warns, however, that new developments could push the Bank of England to cool its zeal for raising rates later in 2022.

He says Oxford Economics now sees just two 25 basis point rate hikes this year, one in April and one in June. Before the Ukraine crisis markets were expecting three, and investors still seem to be positioned for more. Numbers from OIS markets indicate expectations for interest rate hikes totaling up to 130 basis points over the remainder of 2022.

If market expectations re-price lower, it would raise downside risk for Sterling through the rest of the year.

Barclays says that while rates markets have re-set expectations for interest rates in the wake of the Ukraine conflict, expectations for BoE tightening were reigned in the most.

Oxford Economics says the reason it sees so few rate hikes this year is because of an additional squeeze on households coming in October when the UK’s regulated energy price cap expires.

Godwin says the research firm has slashed its UK GDP growth forecast for 2023 by 0.5 percentage points, along with a 0.1 point cut for 2022.

‘BoE policymakers are in an increasingly difficult situation. On the one side, higher inflation will stoke concerns that workers will seek higher wages and businesses increase prices to offset. On the other side there is a squeeze coming on household spending power. Together there is a risk of both a sudden growth slowdown alongside very low inflation’.

British growth outlook sours on upside risks

Other economists are revising their growth forecasts lower, and inflation forecasts higher for the UK economy as the impact of Russia's invasion of Ukraine and subsequent sanctions reveal their knock-on effects.

In a market analysis published this week, Pantheon Macroeconomics. Wrote that the outlook for Britain's economy ‘has darkened in the aftermath of the invasion.’ For that reason, we’ve raised our forecast for peak CPI inflation in April from 7.6 per cent to 8.0 per cent.’

The direct hit from UK and international sanctions to the UK economy is hoped to be more or less contained, with analysts suggesting that just USD 3 billion of the British banking system is directly exposed to Russia’s banks. France, Germany, and Austria all have greater exposure.

BoE Governor Andrew Bailey wrote in The Times last week that the ‘UK banking system’s exposure to Russia is minimal.’ However, oil and gas prices have spiked in the immediate aftermath of the conflict.

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