EUR/GBP set to rebound in 2018 - Natixis

"After a lengthy correction that got underway back in May, sterling recovered steadily over the course of September, before leveling off since the start of October," analysts at Natixis point out.

Key quotes:

"Despite some quite significant swings, implied volatility for the EUR/GBP remains low at almost 7%, reflecting the sentiment that sterling is not expected to budge much in coming month, like the EUR/USD, in the absence of major news. Yet, uncertainties are rife at both macroeconomic and political levels. Our view is that sterling’s recent rebound in September will not show lasting power, on the contrary, as the currency looks set to resume its descent in coming quarters. In the short to medium term, sterling’s main determinants will be developments as regards GDP growth, the Bank of England’s key policy rates and Brexit negotiations."

"Sterling’s rebound in September was fuelled mainly by the prospect of a hike in the Bank of England’s bank rate spurred by the upturn in inflation and by concerns of greater inflationary pressures now that there is little slack in production capacities. The market now prices in expectations of a hike in the bank rate before the end of 2017, followed by another in H2 2018. Since the end of September, these expectations have subsided somewhat, in reaction to the slump of the construction PMI, which is now back below 50, and more generally to the deterioration of the macroeconomic indicators."

"Very little progress has been achieved regarding Britain’s exit, with the 4th negotiating round having ended. The 5th negotiating round will get under way on 9 October, still over the first phase issues (status of Eurozone citizens, Irish border and divorce bill). The European Council will then consider what progress has been achieved on the occasion of the European Summit that will be held on 19 and 20 October. It is rather unlikely there will have been any significant breakthroughs in the interval, notably over Britain’s financial commitments, considering the UK puts these at €20bn, the EU at between €60bn and €100bn. Moving to the second phase, and opening negotiations over a trade agreement, could prove difficult, not to say most unlikely in the short term. Be that as it may, a 2- year transition period could be agreed, which will prolong further the uncertainties and, hence, continue to discourage investment by companies."

"Under these conditions, sterling can be expected to resume its descent in coming quarters. We see the current 0.88 level for the EUR/GBP as a good entry level to play the pair’s rebound towards 0.95 mid-2018. The risk is a weaker euro due to the current political crisis in Spain."