Alert: Euro Pound (EUR/GBP) Shoots Higher on ECB, But Outlook Remains Rangebound

The euro to pound exchange rate (EUR/GBP) was thought to be at the start of a new leg lower with a test of 0.72 being tipped for early 2015.

While this scnenario could still well play out we note currency markets are frantically buying the euro following the December ECB policy meeting and press conference.

The euro to pound exchange rate (EUR/GBP) is seen to rocketed to 0.7900 on news that there is no news to deliver regarding further quantitative easing action at the ECB.

As can be seen in the below graphic a well-defined range has been established for the pair and a retest of the bottom of the range could still well transpire:

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A Lower Euro Sterling Exchange Rate

Trading veteran Sean Lee at ForexTell is of the opinion the euro pound rate remains ripe for a decline:

"The EUR still looks pretty sick to me but I’m also of the opinion that cable is close to ‘must-buy’ levels. Whether this is 1.5500 of 1.5350, I simply don’t know, but what I am sure of is that we are close to a base in cable.

"The obvious way to trade this view is through a short EUR/GBP position. I’ve worn a few volatile swings already and will continue to build, getting more aggressive if EUR/USD breaks lower onto a new plane. Target levels are around .72/.73 early next year."

However, getting too agressive on the shared currency may prove to be premature.

"As is the case for several other major currency cross rates, EUR/GBP is firmly locked within a tight sideways range capped by the 0.8066 range top. A strong bottom is in place in the 0.7800/0.7755 area. EUR/GBP is more or less in the middle of this range. The downside is slightly favoured short-term, but we don’t see a trigger for a break outside the range," says Piet Lammens at KBC Markets.

What Could Drive The EUR/GBP Lower?

One source of pressure on the euro sterling exchange rate will be the continued strength in the UK economy.

"Notwithstanding political uncertainty surrounding May’s general election and the deterioration of growth in Europe, an improving UK economic outlook should prove the dominant factor for GBP in the coming months," says Adam Myers, Senior FX Strategist at Crédit Agricole.

We hear from the Bank of England this week as to whether they are to make any changes to interest rate policy - markets are unanimous in expecting no change.

What will be important is whether a negative (or 'dovish') tone is struck by the BoE - the decision to take a more cautious communication by the Bank has kept sterling under pressure in recent months allowing the euro to make gains.

"With BoE rate expectations already marked significantly lower in recent months, even MPC doves are unlikely to push any harder on the policy door this week," says Myers.

In turn, Credit Agricole view the recent deterioration in UK rate spreads as having moved far enough, leaving GBP poised for a correction higher given a growing body of Q4 evidence supporting a still strong UK growth outlook.

The ECB is the Hammer that Will Crack the Nut

For us the catalyst to a major decline in the euro exchange rate complex will be the European Central Bank (ECB).

It is unlikely that further easing action will be taken at this week’s monthly ECB policy meeting, but we might see more dovish commentary.

Prospects for European Central Bank (ECB) quantitative easing are looking higher as policymakers’ rhetoric continues to build.

ECB Vice President Constantio stated last week that the ECB would have to assess the situation in the first quarter in 2015 and if there was no progress the Bank would “consider buying assets, including sovereign bonds in the secondary market.”

This follows November’s ECB policy meeting which left the door open to quantitative easing, when President Draghi reassured the market of the unanimity of policymakers’ intention to expand the ECB’s balance sheet to €3 trillion through asset purchases and the targeted-long-term refinancing operations.

A number of large investment banks and economists predict the big move by the ECB - which will push the euro exchange rate complex lower - will come around March 2015.

ECB policy support should help to raise eurozone growth expectations in 2015 while sending the euro lower as the volume of currency in circulation is increased.

However, the timing of the expansion of the ECB's balance sheet is questionable and this is where we see the euro finding potential support.

More evidence is showing economic data stabilising.

"Bank lending to non-financial corporates has been depressed, but it increased by nearly €28 billion in September from the previous month, while the rate of decline on a year ago has slowed. It’s early days, but now that the ECB’s Asset Quality Review and stress tests are out of the way, we should see more appetite for lending in conjunction with an easing of credit standards, as evidenced in the ECB’s October Bank Lending Survey," says Jaisal Pastakia, Investment Manager at Heartwood Investment Management.

More encouraging growth signs are also emerging out of Germany, which suffered a setback over the summer.

"We continue to await stronger manufacturing data – the latest third quarter German GDP data showed lagging business investment versus relatively strong consumer spending and robust export growth. However, investor confidence and business surveys (ZEW and IFO) are improving and the unemployment rate continues to make record lows," says Pastakia.