Pound-Euro Week Ahead: Charts Point Lower as Bearish Sentiment Builds, Sterling Sold Again 

- Underperformance leaves GBP/EUR balanced on knife edge.
- GBP/EUR draws more sellers as fundamental headwinds build. 
- But may find support Sun & Mon if EU Council outcome rankles.

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The Pound-to-Euro rate slumped last week as Sterling underperformed but it could be liable for further declines in the coming days because the technical backdrop on the charts has deteriorated and bearish sentiment is beginning to build around the British currency.

Sterling was out of favour as a May economic bounceback failed to show up in Office for National Statistics data and the Bank of England revived concerns about a policy pivot to negative interest rates, both helping to send the Pound to the bottom of the major currency bucket. 

The Pound-to-Euro rate fell -1.54% over the course of the week in one of Sterling's worst performances against its major rivals, leaving it trading just below the 1.10 handle at the Friday close and with nearly 100 points until the next support level, which is the 61.8% Fibonacci retracement at 1.0911. 

"2-year gilt yields fell below JGBs' this week, and there is still no visible progress on a trade deal with the EU," says Kit Juckes, chief FX strategist at Societe Generale. "The UK released strong BRC sales data for June, and weaker than expected data on GDP, industrial production, services output, and construction, for May. Labour market data show weak employment, and unemployment falling but only because many workers are withdrawing from the market."

Above: Pound Sterling performance against major rivals last week. Source: Pound Sterling Live. 

The charts are warning of further downside lurking on the path ahead for Sterling, which has also been placed up for sale at MUFG this last week in another example of deteriorating sentiment toward the British currency. MUFG noted how Sterling has slipped lower against major rivals even as risk appetite remained robust enough to push stock markets higher, before floating the question of what might happen to it if the market mood darkened.

"GBP was the 2nd worst performing G10 currency in Q2 (JPY worst) and if NOK continues to rally, GBP will soon be the worst on a year-to-date basis. We don’t see this reversing," says Derek Halpenny, head of research, global markets EMEA & international securities at MUFG. "We are choosing the euro as the currency to sell the pound against. EUR/GBP looks to be on a gradual trend higher since the start of May and we are now close to breaching the resistance trendline from the postCOVID high in March and the high toward the end of June. A breach of that resistance would open up a test of that June high."

MUFG advocated that clients sell the Pound-to-Euro rate at 1.10 and target a move down to 1.0683 over the coming weeks and months, preferring GBP/EUR as a means of exposure to anticipated underperformance instead of GBP/USD.

Technical analysts at Commerzbank have also advocated selling Sterling, though upon a rebound to 1.111. 

“A move above the .9178 June high would trigger a rise to .9323. It is the location of the 78.6% Fibonacci retracement,” says Axel Rudolph, a senior technical analyst at Commerzbank, who says there's scope for the Pound-to-Euro rate to fall to 1.0526 over the next one-to-three months. 

Above: Pound-to-Euro rate shown at daily intervals with Fibonacci retracements of March recovery and 21, 55 (red) and 200-day (green) moving-averages.

The UK economy suffered greater damage than many of its major counterparts during the lockdown of April, May and June and is thought to be recovering from its trough slower than other major economies too. This is a headwind for Sterling, though one that is compounded by the Bank of England's ongoing contemplation of negative interest rates as well as the Brexit trade talks, which are yet to yield any material signs of an agreement being in the pipeline. 

"GBP is an international reserve currency that trades more like an emerging market. Thanks to the UK large current account deficit GBP trades in line with global risk sentiment and in line with moves in CNH. Global risk sentiment and CNH remain supported for now, explaining GBP/USD’s recent move higher. This is partly why we chose EUR/GBP as a clearer expression of our short GBP view, while holding long EUR/USD," says Jordan Rochester, a strategist at Nomura. 

The Pound's litany of domestic headwinds are enough to ensure it underperforms on the good days and the bad and will condemn it to further losses in the months ahead without progress toward a trade agreement in the Brexit negotiations or signs of a stronger economic recovery. But the Pound-to-Euro rate could receive a boost Sunday and Monday if investors take adversely the outcome of the special European Council meeting. 

The meeting overran as leaders sought unanimity on the €750 billion recovery fund and next seven year EU budget. At the time of writing, European Council President Charles Michel had proposed reducing the contingent of grant funding from €500bn to €450bn but talks remained deadlocked. EUR/USD would be vulnerable if the talks end without agreement and if it looks at the same time as if the grant contingent will need to be reduced further. 

Above: Pound-to-Euro rate shown at daily intervals alongside Euro-to-Dollar rate (orange line).

"GBP/USD would likely tick higher mainly driven by the rise in the EUR/USD, with a limited potential for GBP/USD to outperform EUR/USD as GBP still faces the well-known headwinds (the future of the EU-UK relationship) which does not advocate a bullish GBP case for months to come," says Petr Krpata, chief EMEA strategist for currencies and bonds at ING. 

Any EUR/USD losses seen early in the new week could offer support to the Pound-to-Euro rate if GBP/USD goes unaffected, although there's also a flip side to that because a surprise agreement would drive EUR/USD higher and if the move isn't matched by the Pound-to-Dollar rate then GBP/EUR would come under pressure. Beyond the Monday open Sterling's attention will turn back to the Brexit negotiations, where an update from negotiators is expected on Thursday or Friday, and to economic data. 

June retail sales are out Friday at 07:00 and are followed by July's flash PMI surveys of the manufacturing and services sector from IHS Markit at 09:30, though Sterling might be more sensitive to any disappointments than it will be to upside surprises. Retail sales are seen rising by 8% after having rebounded 12% in May, which partially backfilled the -18.2% decline seen in April.

The IHS Markit services PMI is seen rising from 47.1 to 51.1 while the manufacturing index is seen edging higher to 52, from 50.1 in June. However, investors have taken the PMI surveys with a pinch of salt in recent months. Investor sentiment reflected in the performance of stock markets will be a more important influence on the Pound, alongside the technical picture on the charts as well as fundamental factors like the prospect of progress in the Brexit talks. 

Above: Pound-to-Euro rate shown at weekly intervals with 21, 55 (red) and 200-week (green) moving-averages.