Synopsis:

Despite recent GBP outperformance, Credit Agricole warns that fundamental drivers do not support continued strength. Relative sovereign credit risk and central bank policy expectations suggest that EUR/GBP is undervalued, creating downside risks for GBP.

Key Points:

1️⃣ GBP Has Outperformed, But Against Broader USD Moves 💷

• Recent EUR/GBP weakness has been driven by USD movements rather than strong UK fundamentals.
• GBP/USD and EUR/USD have mirrored broader USD trends rather than reflecting UK-specific strength.

2️⃣ Sovereign Credit Risk Does Not Justify GBP Strength ⚠️

• UK’s sovereign credit risk, measured by the UK-French 5Y CDS spread, has been steadily recovering from early-year lows.
• Widening credit spreads typically support a weaker GBP, but EUR/GBP has yet to reflect this shift.

3️⃣ Rate Spread Favors EUR Over GBP 🔄

• The 2Y EUR-GBP rate spread (a proxy for ECB vs. BoE policy outlook) has been recovering from multi-year lows.
• Despite this, EUR/GBP remains weak, suggesting the FX market has not fully priced in rate differentials.

4️⃣ A Gap Between EUR/GBP Spot and Fair Value Exists ⚖️

• A divergence has opened between EUR/GBP’s spot rate and its fair value estimate based on rate spreads and peripheral credit risks.
• This suggests GBP strength may be overstretched, making it vulnerable to a correction.

Conclusion:

GBP’s recent gains may be unsustainable, as fundamental drivers like sovereign credit risk and relative rate spreads indicate EUR/GBP is undervalued. Traders should be cautious as these factors could drive a GBP reversal in the near term.