Pound to Euro Exchange Rate Pierces Range Lows as UK Property Funds Collapse

The British pound continues to be sold in aggressive fashion as traders and investors continue to liquidate exposure to the UK currency.

It is not just the UK that is seeing negative investor sentiment - European markets are in the red with the German 30 index of leading stocks down by 0.77% at the time of writing.

This corresponds to a 0.77% decline in the pound to dolar exchange rate and a 0.63% decline in then pound to euro exchange rate. 

European investors are withdrawing capital from the UK, and other global markets for that matter, as there appear to be many concerns afflicting investors.

A simmering Italian banking crisis is one of them but most commentators appear to be laying the blame at the door of Brexit.

Three major U.K. property funds to suspend redemptions - Aviva, the U.K.'s largest insurer, Standard Life and M&G Investments.

"Since Brexit, we've seen property stocks plunge - the U.K. property market has been a longtime favorite of foreign investors but Brexit uncertainty caused many investors to drop out of deals or rush to list their holdings. Right now we have just started to see the value of property funds and REITs fall but in the coming weeks and months, Britons will start to see their property values decline, creating greater reasons for consumer retrenchment," says Kathy Lien, Director at BK Asset Management.

However it is important to note that there are two kinds of property declines - one caused by a systemic failure of the banking sector (think 2008) and that caused by the withdrawl of foreign investor funds.

As long as mortgage lending continues then we could actually be seeing a well overdue shakeup of the UK property market that has for too long be fuelled by foreign capital at the expense of locals.

Nevertheless, a weaker pound is one by product of the adjustment.

Analyst Sean Lee at Forextell says he believes the British pound is akin to a falling knife and as yet there is little evidence to suggest a stabilisation or recovery is due. 

Lee expects to see GBP/EUR below 1.1100 “in coming weeks” but some moments of relief may be expected if and when some short-term bearish EUR sentiment resurfaces.

However, this relief is likely to only attract further selling interest and those institutions calling for a fall to parity in GBP/EUR appear to be on the money.

Bank of England's Carney Reassures Markets

mark carney pound exchange rate 2

The Bank of England's Mark Carney announced a new measure to support bank lending on Tuesday as fears increased that the UK might be falling into a recession following its decision to vote to leave the EU.

The new measure was also announced in the bank’s Financial Stability Report (FSR) released just before Carney’s press conference.

The policy change from the BOE means banks can reduce what is called the “countercyclical capital buffer”.

This is a requirement to maintain capital worth 0.5% of the bank’s total UK exposure.

It was designed so that banks could build a capital base during the good times to help them weather the bad times.

Such a rainy day now appears to have arrived post-Brexit, so the BOE decided to reduce the buffer back to 0.0% in Tuesday’s report.

Dark Horizon

The Financial Stability Report outlined the BOE’s concerns for the outlook of the economy, which included the following:

1) A deterioration in the ability of foreign investment to finance the United Kingdom’s large current account deficit;

2) A decline in the UK commercial real estate (CRE) market, which had experienced particularly strong inflows of capital from overseas and where valuations in some segments of the market had become stretched;

3) The danger from the relatively high levels of UK household debt combined with the threat of higher unemployment that borrowers will default;

4) The potential for buy-to-let investors to behave procyclically, amplifying movements in the housing market;

5) Subdued growth in the global economy, including the euro area, which could be exacerbated by a prolonged period of heightened uncertainty; and

6) Fragilities in financial market functioning, which could be tested during a period of elevated market activity and volatility.

Deficit Danger

The report raised concerns in particular about the UK’s record high Current Account (CA) deficit which stood at 32bn in May.

Previously the CA deficit was balanced by foreign investment, particularly foreign investors purchasing UK stocks, shares and other financial assets.

However, the report notes that in the run up to the referendum foreign investors increasingly shied away from ‘buying British’ due to the high level of uncertainty about the outlook both politically and economically.

The growing hole was one of the causes of the collapse of the pound.

The FSR highlighted the potential for a CA crisis to evolve if foreign investors continued to be deterred from purchasing UK investment products:

“During a prolonged period of heightened uncertainty, the risk premium on UK assets could rise further and overseas investors could continue to be deterred from investing in the United Kingdom.

“Persistent falls in capital inflows would be associated with further downward pressure on the exchange rate and tighter funding conditions for UK borrowers.” It said.

Carney also stated, however, that one upside of the downward adjustment in Sterling was that it would help the economy adjust to the new economic reality, as it would make UK exports cheaper, increasing their attraction.

Analysts now expect the BOE to cut the base lending rate to 0.25% in July, while a potential expansion of the MPC asset purchase programme is also possible.

Services Dip

A lower-than-expected slow-down in the Services sector in June, as measured by Services PMI, further weakened the pound earlier in the day, after coming out at 52.3 from 53.5 in June.

The slow-down in Services comes after data out on Monday showed Construction PMI moving into contraction territory. Whilst not as extreme as the fall in Construction, Services is a larger sector.

Last Friday’s Manufacturing PMI actually came out higher, perhaps buoyed by a weaker pound. The more export orientated Manufacturing sector is likely to be helped on an ongoing basis by the weak pound which was a consequence of Brexit.   

From a technical viewpoint, the currency looks bearish in most of its pairs, and appears to be probing, or in some cases breaking out below current range lows, and potentially beginning another leg lower.

GBP/EUR breached a confirmation level at 1.1850, which we suggested would signal more downside.

It could now potentially fall all the way to 1.17 -16, before hitting tougher support in the 1.1560s.

GBP/USD has breached the bottom of its range between 1.31 and 1.35.

With the break below these 35 year lows the pair is now expected to continue lower to the next target at 1.3000 initially, followed by 1.2700, using the height of the previous 1.31-35 range as a guide and extrapolating it lower.