FX Focus: Pound and euro heading for a post-Brexit 'lose-lose' situation

Market sentiment is increasingly turning towards Brexit hurting both the pound and euro, with the dollar witnessing a period of strengthening on heightened US interest rate hike expectations.

At 2.33pm BST on Wednesday (12 October), the pound was up 0.70% versus the greenback to $1.2208, having clawed back some but not all of the losses seen over the previous two trading sessions. However, with traders taking a bet on reduced chances of a Donald Trump victory and pricing in the possibility of a US interest rate hike this year, it was the euro's turn to take a hammering at the hands of the American currency.

Having suffered slides in Asia, the euro extended intraday European losses by 0.34% exchanging at $1.1016; a two-month low, with chances of December US rate hike fractionally above 70%, according to traders.

The pound also clawed back recent losses against the euro registering a 1.00% rise and exchanging at €1.112, with many opining a "lose-lose" situation could arise from Brexit talks.

David Bloom, strategist at HSBC, feels the pound could fall to $1.10 by the end of 2017 and may hit parity against the euro, with the currencies last having been that close in 2008.

"The pound is now the de facto official opposition to the UK government's policies. It is becoming clear that many European countries will come to the negotiation table looking for political damage limitation rather than economic damage limitation; a lose-lose situation is the inevitable outcome," Bloom said.

David Buik, markets commentator at Panmure Gordon, said the prospect of a messy Brexit was among the many worries confronting the European Central Bank (ECB).

"There is very good chance Angela Merkel could lose the German chancellorship in 2017. Greece could fall anytime, Italy remains politically precarious, Spain has failed to resolve its political stalemate – wherever you look Europe is an absolute mess. I very much doubt the EU will continue to survive in its present state. Sidestepping volatility in the value of the sterling, the euro remains in a terrible place and appears overvalued."

Furthermore, the ECB's policy stance remains dovish, and the Bank of England could opt to cut interest rates again putting pressure on the pound, according to Alexandra Russell-Oliver, foreign exchange analyst at Caxton.

"So far, post-Brexit UK data has not been as negative as some had feared which lessened the expectation of the Bank of England acting. But there is still an expectation."

Meanwhile, the dollar also posted a 0.31% gain versus the yen, exchanging at JPY103.88, after Bank of Japan governor Haruhiko Kuroda said the bank could take more monetary action contingent upon market circumstances.

Hans Redeker, global head of FX strategy at Morgan Stanley, said selling pressure on the yen was likely to intensify. "The consensus view is for the yen to strengthen. We continue to disagree, and see views elsewhere coming round to ours, in line with the price action in USD/JPY, which has had some upside momentum following the break of some technical levels watched by the market. We expect this process has further to run."