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Pound depreciation against euro: A short-term undervaluation trend

The ongoing depreciation of the pound against the euro has provoked many analysts to bet on the parity of these two currencies by the end of the year. However, even top financial firms that still advise investors to ride the tide against the pound, admit that they do so based on the prevailing uncertainty bias over Brexit. This bias is manifested through the contradictory perceptions of investors over the performance of the UK economy. Particularly, the rising inflation in the UK over the last six months has led to the fall of the pound based on growing concerns for a massive growth deceleration of the economy. On the other hand, the fortunate signs of a stabilization of inflation caused a reaction that was the opposite of what was expected, as expectations of interest rate hikes have receded.
In contrast, the short-term expectations of the tampering of the ECB’s quantitative easing program have been multiplied based on the improving macroeconomic conditions of the Eurozone. However, the “outperformance” of the Eurozone economy that boosted the confidence of investors over the single currency cannot last based on the constant appreciation of the latter. Indeed, the interests of the Eurozone over trade competitiveness do not lie on a stronger currency. Additionally, its macroeconomic figures, related to inflation and wage growth, are still fragile to risk an attempt to abandon relaxed monetary policy. Accordingly, these reasons seem sufficient to believe that a tighter monetary policy in the Eurozone will not be finally realized, while this likelihood cannot be excluded for the UK. Thus, the long term outlook of the GBP to EUR exchange rate will be subject to a correction phase.