Slump in Risk Appetite Hurts Pound to Euro Exchange Rate

August 7, 2024 - Written by John Cameron

STORY LINK Slump in Risk Appetite Hurts Pound to Euro Exchange Rate

A slump in global risk appetite has hurt the Pound in global markets with aggressive covering of short yen positions.

The Pound had benefitted from carry trades with global investors selling the yen to fund long positions in high-yield instruments including the Pound.

This process has now slammed into reverse with GBP/JPY, for example slumping to 7-month lows.

Equities have moved sharply lower with the FTSE 100 index dipping below the 8,000 level and bond yields have declined sharply.

ING commented; “We think the marked correction in equities is keeping high beta currencies under pressure.”

The Euro is also vulnerable to some extent, but has gained in relative terms.

Friday’s US jobs data increased fears that the US economy is sliding into recession. There are also concerns over increased Middle East tensions.

The Pound to Euro (GBP/EUR) exchange rate has posted further sharp losses to 11-week lows at 1.1660 before a slight recovery to 1.1690 amid a spike in volatility.

The Pound was also hampered to some extent by the Bank of England (BoE) interest rate cut last week, although the slide in global risk conditions has been the key element.

The UK currency is correlated strongly with risk trends. When equity markets are strong and there is strong interest in carry trades, the Pound performs well.

When conditions deteriorate, however, the Pound comes under pressure.

MUFG commented; “The GBP has been undermined by the marked deterioration in global investor risk sentiment. Global equity markets have been correcting sharply lower since the middle of last month which is encouraging an unwind of carry trade positions.

The latest COT data, released by the CFTC, reported a decline in long Pound positions to 111,000 contracts from a record high of over 142,000 previously, but this is still a very high figure.

MUFG added; “Long GBP positions held by leveraged funds prior to the recent correction lower for global equity markets had reached their highest levels since April 2018. It leaves the GBP vulnerable to further weakness in the near-term from the scaling back of excessive long positioning.”

As far as economic data is concerned, the July Euro-Zone composite PMI business confidence index was revised marginally higher to 50.2 from the flash reading of 50.1, but lower than the June reading of 50.9.

Danske Bank is still relatively optimistic over the Euro-Zone outlook; “We estimate that seasonality explains some of the weakening in the PMIs over the summer. Looking ahead, we thus expect the services sector to continue fuelling growth given rising real incomes and a strong labour market.”

The UK PMI composite index was revised marginally higher to 52.8 for July from the flash reading of 52.7 and compared with a June reading of 52.3.

The data will maintain expectations of a gradual improvement in UK conditions and should limit Pound selling.

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TAGS: Pound Euro Forecasts