The British pound is 10% overvalued against the euro

If you’re going on holiday to Europe and haven’t yet bought any euros, maybe you should hurry. Unless Greece really exits the eurozone (and that can still happen), the pound’s advance versus the euro seems limited from here on.

The British pound is about 10% overvalued compared to the euro relative to purchasing power parity – a measure of the exchange rate that adjusts it for inflation – according to Kit Juckes, Societe Generale’s foreign exchange analyst.

Pound overvalued vs the euro

The pound is overvalued agains the euro. Source: Societe Generale

Juckes believes the pound “will struggle to make much further headway against the euro”, and he targets an exchange rate of £0.69 for one euro as the low, somewhere around the end of the first quarter of next year.

“This will coincide with EUR/USD trading around parity,” he wrote in recent research. “We look for GBP/USD, correspondingly, to be dragged down by the euro, reaching a level of 1.45 at the lows.”

A survey of fund managers carried out before the Federal Open Market Committee’s meeting last week showed investors expect the single European currency to remain weak against the dollar.

The euro can recover when the market will switch its focus to the timing of the first rate hike by the European Central Bank (ECB) and the end of its bond-buying programme, Juckes said.

The ECB’s quantitative easing is scheduled to last at least until September 2016, but “the euro bounce can start well before then,” as the market tries to stay ahead.

However, the US Fed and the Bank of England will both still be raising interest rates through 2017, so the euro’s appreciation should be slow, in his opinion.

The UK economic cycle has already peaked, but Juckes does not expect monetary policy easing by the Bank of England until 2019.

The pound’s overvaluation versus the euro is “not as extreme” as it was between 2006 and 2008, but sterling has bounced nearly 25% in real terms from the low it hit in 2009.

“Even if the late 2008 collapse needed to be partially reversed, the impact of the pound’s recovery on inflation, profit margins and competitiveness is significant and will severely limit further potential for sterling strength,” Juckes added.

He sees the UK’s referendum on whether to leave the European Union as the main threat to the currency, followed by an earlier slowdown of the economy than forecast because of the impact of austerity.