Pound surges to year high on euro weakness and French debt fears

The pound-to-euro exchange rate surged to its highest level of the year, reaching 1.1802 on Monday, as hedge funds heavily sold the euro. This selling spree followed concerns over French government debt, where the ten-year spread over Germany hit its widest point since 2011. Thu Lan Nguyen, Head of FX and Commodity Research at Commerzbank, noted that markets are increasingly worried about the sustainability of France's public debt, which is now impacting the euro.

The euro's weakness stems from the potential conflict facing the European Central Bank (ECB). The ECB may have to balance its price stability mandate with its financial stability responsibility, particularly if it needs to intervene to ease pressure on long-term bond yields. This scenario could force the ECB into a more accommodative monetary policy, which would weaken the euro further.

The pound's strength is also supported by the gilt market, where ten-year yields are now only 10 basis points above US Treasuries. However, the pound-to-euro rate's rapid advance has pushed it into overbought territory, suggesting that the pace of the advance may not be sustained, even if the upward trend continues. The next key resistance level for the pound-to-euro rate is July's peak at 1.1828.

Commerzbank cautions that the euro's weakness could be limited as long as investors have access to German bonds as a safe asset. However, any signs of contagion spreading from France to other eurozone countries, particularly Germany, could signal further euro depreciation. The growth data for the eurozone remains cautious, with indicators pointing to modest growth in the third quarter.