The Pound-Euro Week Ahead: Range Trading after Sterling's Rally Endangers GBP/EUR Downtrend

- GBP/EUR downtrend in danger after strongest week since March.
- 1.0950-to-1.11 range possible as GBP & EUR consolidate Vs USD.
- But BoE meeting a wild card as negative rate and virus fears linger.

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The Pound-to-Euro exchange rate may have set itself up for a period of range-trading after its strongest performance since March put a multi-month downtrend in danger, with Sterling having declined an invitation to return to earlier lows. 

Pound Sterling was the best performing major currency last week after months of underperformance conspired with a reappraisal of UK economic progress to enable the British currency to belatedly benefit from a U.S. Dollar exodus.

The Pound-to-Dollar rate advanced 2.27% by the time all was said and done, the strongest performance of any major currency that helped lift the Pound-to-Euro rate off what may be becoming a range floor near the 1.0950 level. 

The Pound-to-Euro rate rose to 1.1135 at its peak before ebbing into the weekend, leading some to contemplate whether 1.1111 would be breached on a daily closing basis. That level is equal to the 0.90 threshold for EUR/GBP and is key to the technical trend in the exchange rate.

"This is not the benign dollar decline we had envisaged, but instead, one seemingly being driven on a new risk premium being inserted into US asset markets on the back of a resurgence in US Covid-19 cases and perhaps as well November's presidential elections starting to make their mark," says Chris Turner, head of markets and regional head of research at ING. "Somewhat surprisingly, GBP has managed to out-perform the resurgent EUR and EUR/GBP is threatening to break under 0.90. Positioning may have played a role here, but we think it is too early to wholeheartedly back GBP." 

Above: GBP/EUR at daily intervals with S&P 500 (orange line, left axis) and relative strength index measure of momentum.

In the week ahead the most important factor for the Pound-to-Euro exchange rate will be the relative pace of gains or losses for GBP/USD and EUR/USD, although the rub for Sterling traders is that both bullish and bearish scenarios for those two still leave GBP/EUR stuck within a 1.095-to-1.11 range. 

GBP/USD and EUR/USD have risen strongly of late while the Dollar Index has fallen to multi-year lows and by many accounts each is either oversold or overbought, meaning a period of consolidation or even correction is likely. 

"The shift higher is a result of overwhelming dollar capitulation and the fact the pound is considered more undervalued against the US currency compared to other G10 currencies. As a comparison, GBP/EUR is only up circa.1% this month. If we see some positive Brexit news, then GBP/EUR could charge higher too, but overall investors remain generally bearish on the pound – meaning they expect it to weaken in the future given the uncertainties that hang over the UK economy such as Brexit and the impact of coronavirus and threat of second wave," says George Vessey, a currency strategist at Western Union Business Solutions. "GBP/EUR may be at risk of falling if EUR/USD continues to rise, though has so far held up against the recent moves largely as a result of the rapid ascent of GBP/USD alongside the EUR/USD climb."

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

The Pound-to-Dollar rate faces technical resistance around 1.32 and might not have much in the way of support before the 1.2750-to-1.28 area. EUR/USD has support coming from the 23.6% Fibonacci retracement of its May rally at 1.1640 and could find resistance coming from last week's high around 1.1904.

These numbers imply a 1.095-to-1.11 range for this week so long as the timing and relative pace of moves in GBP/USD and EUR/USD are about even, although a Bank of England (BoE) policy announcement at 12:00 on Thursday might be enough to put this range in jeopardy. 

"The GBP has performed well over the past month with only the NOK and SEK on course to outperform amongst G10 currencies. Broad-based USD weakness has helped to lift cable by almost 6% in July. It is the strongest monthly performance since May 2009," says Lee Hardman, a currency analyst at MUFG. "In the process, the GBP has become heavily overbought against the USD suggesting caution in continuing to chase cable higher in the near-term. However, the GBP’s recent performance on a trade-weighted basis has been less impressive as it remains around -1.7% lower than in late April." 

Above: GBP/EUR at weekly intervals with relative-strength-index measure of momentum. RSI did not confirm new March 2020 low, which left in its wake a 'bearish divergence' between price and RSI that typically indicates a change of trend.

Hardman and the MUFG team have closed a bearish wager against the Pound-to-Euro rate after last week's performance from Sterling and have grown cautious about the outlook ahead of Thursday's 12:00 BoE meeting. They say that if Governor Andrew Bailey fails to provide a signal that further support for the economy is likely before year-end then Sterling could extend its recent advance against the Dollar, which might mean a higher Pound-to-Euro rate too. 

But they've also warned that any further interest in using negative rates as a policy tool would be likely be taken badly by the Pound, which could put both Pound-to-Dollar and Pound-to-Euro exchange rates on the back foot. The BoE reduced the pace at which it buys government bonds each week through its £745 bn quantitative easing programme in May and since then the government has not loosened its purse strings any further. 

"Market participants will be closely scrutinizing the BoE’s upcoming policy meeting on Thursday for a fresh GBP catalyst," Hardman says. "We still expect the BoE to express caution over the highly uncertain economic outlook given the risk of further disruption from a second COVID wave, and the risk of another hit to growth later this year when the job furlough scheme expires in the autumn. The NIESR has warned that the government’s decision to bring a premature end to the scheme will result in unemployment rising above 3 million and the unemployment rate to almost 10%. As a result, we believe that the BoE will deliver further policy stimulus in November. It leaves the upcoming BoE meeting finely balanced for the GBP."