The euro seems to be replacing sterling as currency traders’ victim of choice. The battered pound has won a reprieve because Britain’s economy is proving more resilient than anticipated after the 2016 vote to leave the European Union. By contrast, the single currency’s star is waning before France’s unpredictable elections.
Far-right leader Marine Le Pen has rattled investors by promising to take France out of the euro zone and hold a referendum on EU membership. While polls show she will be easily defeated in the second round of presidential elections in May, there has been enough flux among the other frontrunners for Le Pen’s rhetoric to weigh on the euro and French bond prices, and to push up the cost of insuring against a Gallic default.
Just as the euro’s prospects darken, the outlook for sterling is turning a bit less gloomy. Positive economic surprises have outstripped negative ones by a bigger margin in Britain than in the United States or the euro zone, according to Citi gauges. For example, manufacturing grew more strongly than expected in December, official data showed on Friday. Higher inflation could also support the pound by forcing investors to rethink how long Bank of England Governor Mark Carney can keep policy rates at rock-bottom lows.
The changing fortunes of these two currencies are already evident in the derivatives market. For most of this year, three-month currency option prices showed investors had a preference for buying euros rather than pounds. This switched around in the past week. They now have a preference to sell the single currency for sterling, and that preference is at its most marked since 2015.