ExchangeRates.org.uk - The consensus forecast among investment banks is that the Pound to Euro exchange rate (GBP/EUR) will strengthen to 1.2200 at the end of the year from around 1.2050 at the end of 2024.Some investment banks expect more substantial Pound gains.
HSBC (LON:HSBA) does have reservations over the UK outlook, but its central case is that it will out-perform the Euro-Zone and this will maintain upward pressure on GBP/EUR.
It forecasts that GBP/EUR will strengthen to 1.25 at the end of 2025.
According to HSBC; “Although still plagued by numerous headwinds to growth, we think the UK is better positioned to face the current set of global challenges than the eurozone.
This leaves the UK likely to perform midway between the strong US economy and weaker eurozone economy, sending EUR-GBP to fall to 0.80 by Q3 2025.”
HSBC focussed on Euro-Zone difficulties; “Political instability now envelopes the eurozone’s two largest economies, Germany and France, preventing Berlin from addressing lost industrial competitiveness and hampering Macron’s plans to stabilise soaring Gallic debt.
To complicate things further, US President-elect Trump has threatened tariffs on imports from Europe while holding back on supporting Washington’s long-standing European defence guarantee.”
ING noted near-term Pound support; “We think this trend is primarily being driven by the BoE versus ECB story.
But warmer relations between the UK and the EU can’t hurt.
Equally, the eurozone’s fiscal straitjacket should mean the UK economy does outperform in 2025.”
HSBC also noted the potential for closer UK-EU relations; “Improved trust could strengthen investor confidence, supporting FDI flows into the UK which would provide a more stable funding base for the UK’s current account.”
There is very little in the way of dissent on the near-term view.
Danske Bank (CSE:DANSKE) commented; “GBP continues to benefit from a hawkish BoE, inflation and wage growth remaining elevated and underlying growth in the UK outperforming the Eurozone.
We think these forces will continue to weigh on the cross also in the coming quarters.”
RBC Capital Markets (RBC) considers that the UK is less exposed to global trade threats; “Externally, we think the UK is less vulnerable than some other economies, such as the Euro area, to tariff risks under Trump’s presidency.
If the potential tariffs are focused on goods imports, then the UK should be more insulated due to services making up around two-thirds of its exports to the US.”
Beyond the near term, however, several investment banks have greater reservations over expecting further Pound gains.
According to RBC a lot of ‘bad news’ and Pound ‘good news’ has already been priced in.
It added that traders are already holding substantial long Pound positions, leaving it vulnerable to a correction while it also considers that the Pound is overvalued at current levels.
RBC added; “The hurdle is low for GBP weakness if there are any concerns about UK’s growth outlook or fiscal dynamics, and/or there is a risk-off shock.”
Bank of England policies will be a key element during the year.
At this stage, markets are only pricing in two Bank of England rate cuts for 2025.
If this pricing is sustained, the Pound will maintain a strong yield advantage.
UBS commented; “Although inflation has declined in both regions, the UK’s services and core inflation levels remain too high for the Bank of England (BoE).
As a result, we expect the BoE to take a more cautious approach to easing.
In contrast, on the European mainland, the focus has shifted more decisively from inflation concerns to growth challenges, indicating a greater likelihood of further easing measures.”
The Pound will, however, be vulnerable if the BoE cuts interest rates more aggressively.
ING expects that there will be a notable BoE shift from the first quarter of 2025.
It commented; “we expect 150bp of cuts, against market expectations for around 55bp.”
ING added; “The reason we are not more bearish EUR/GBP in our forecasts is that we think the BoE will crumble around February and open up to a more aggressive easing cycle.
It forecasts GBP/EUR at 1.22 at the end of 2025.
Danske Bank added; “Longer-term some of these GBP tailwinds look set to fade and we expect not least a more dovish BoE to eventually weigh on GBP.”
The ECB has cut the deposit rate to 3.00% from the peak of 4.00% and markets expect further declines to at least 2.25%.
If the ECB halts rate cuts around 2.25%, there is a risk that the UK yield advantage will narrow over the second half of 2025, limiting Pound support
The UK economic performance will also be an important component, especially as GDP is likely to have stalled over the second half of 2024 and potentially contracted slightly.
Goldman Sachs (NYSE:GS) noted some concerns over the outlook; “While Sterling has traded well through the mix of data recently, going forward, a further capitulation in growth momentum stands as a key risk to our view that the Pound can be a regional European outperformer.”
Goldman is, however, maintains a bullish stance on the Pound; “Broader global factors will be more important than any of this for Sterling, in our view.
Namely, the Pound’s procyclical characteristics and its lower vulnerability to tariff risks and trade uncertainty should both support the currency over time, and these serve as the key underpinnings to our continued constructive view on the Pound.”
Goldman forecasts GBP/EUR at 1.2660 at the end of 2025.
RBC is more concerned over UK risks; “if the domestic economic outlook deteriorates, the hurdle is low for GBP-downside, given positioning and relative GBP overvaluation.
It forecasts that GBP/EUR will weaken to 1.1765 at the end of the year.
European politics will be a key focus during the year.
Germany will hold Federal elections on February 23rd after Chancellor Scholz lost a confidence vote.
The centre-right CDU look certain to be the largest party, but coalition-building will be tough, especially with polls suggesting that the far-right AfD could secure around 20% of the vote.
There is also political deadlock in France with a three-way split in parliament.
New elections cannot be called until July.
RBC played down the risks; “as long as Macron stays in his post, major political risk is at bay until the 2027 Presidential election.”
The threat of US tariffs on Europe will also be a key element during the year.
UBS commented; “While both the UK and the Eurozone face risks in this area, we believe the UK is better positioned to handle a scenario of escalating tariffs.”
It notes that the UK has a strong trade surplus in services which are less exposed to tariffs.
It considers that the Euro-Zone is more vulnerable given its reliance on goods exports.
UBS did, however, add; “That said, the UK would likely not emerge unscathed from a trade war, as it remains a highly open and trade-reliant economy.”
2025 Risk factors
The Pound will be vulnerable if there is a sustained deterioration in global risk appetite and a slide in equities.
The Euro will be sold if there is a spike in energy prices, especially for natural gas.
In this context, Ukraine developments will be watched very closely.
The Euro will be at risk if the ECB is forced to cut interest rates more aggressively.
More aggressive action by China to support the economy would tend to support the Euro.
This content was originally published on ExchangeRates.org.uk