Is EUR/GBP a parity trade? - Bank of America Merrill Lynch

From BAML:

In the aftermath of the EU Referendum, the analyst community has made significant revisions to its forecast projections for GBP over the coming quarters. While part of this represents a mark-to-market exercise following the significant post-Referendum depreciation, the market remains split on whether the bulk of the sell-off is behind us or whether the worst is yet to come. Client interactions have increasingly focused on EUR/GBP against the backdrop of an increasing number of analysts calling for EUR/GBP to hit parity in 2017.

While we continue to argue the case for further GBP weakness, our analysis suggests the misalignments that were exerting upward pressure on EUR/GBP earlier this year have largely corrected and in some cases suggest GBP is undervalued versus EUR.Indeed, we would go further and argue that EUR/GBP will struggle to maintain a handle above 0.90.

In our view, selling top-side options in EUR/GBP is not attractive with volatility depressed. However, we would see any move toward 0.90 as an opportunity for the corporate (GBP buying) community to increase longer-term forward hedges.

Reasons why parity may prove elusive:

We do not see the kind of divergences that would suggest that a move toward parity is imminent. For this to happen, GBP would still need to be defined as overvalued versus EUR against a variety of metrics. We currently do not see this nor do we expect that such misalignments will reappear anytime soon. At the start of the year, we highlighted the rising Brexit risk premium that was being built into a variety of UK metrics. Chief among those was the spread between UK CDS versus Germany CDS, which widened as the cost of protection on UK CDS rose in the run up to the EU Referendum (Chart 2). At that point, with EUR/GBP trading at 0.74, we believed there was a risk EUR/GBP would move toward 0.85 based on that divergence. But as Chart 2 now highlights, that gap has been closed andEUR/GBP is now in line with that spread.

...While we have highlighted the risks to GBP from a current account financing perspective, the situation in the Euro Area continues to deteriorate as the net portfolio balance continues to record outflows following the introduction of QE. As a result, the basic balance (current account, adjusted for net portfolio and FDI flows) has moved into deficit for three consecutive quarters  Our point here is that while there are concerns about the UK external situation, the deterioration in the Euro Area's position does not provide meaningful support for sustained EUR/GBP upside.

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Is EUR/GBP a parity trade? - Bank of America Merrill Lynch
Is EUR/GBP a parity trade? - Bank of America Merrill Lynch
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