GBP/EUR Week Ahead Forecast: Gravity Wins Again

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What is the Pound to Euro forecast for the week ahead? We forecast Pound Sterling will try and establish a base following Friday's selloff, with risks of €1.17 if Thursday's ECB decision is interpreted as 'hawkish'.

Pound Sterling fell from 21-month highs against the Euro following Friday's release of above-consensus Eurozone inflation, which spoiled a bullish technical setup and raised the potential of a deeper pullback to 1.17 or below.

Regular readers of our Week Ahead Forecasts will recall that rallies above 1.1720 tend to fail and swiftly reverse, and a succession of closes above here last week signalled the makings of a more decisive uptrend.

The Pound benefited from May's above-consensus inflation print and a dearth of commentary from the Bank of England owing to pre-election purdah, which allowed GBP/EUR to move as high as 1.1784 at one stage.

The test of 21-month highs allowed some euro buyers to take advantage of the best exchange rates in 21 months. However, dealers at international payment companies told us that some were opting to hold tight, hoping for even stronger exchange rates.

Unfortunately, this strategy of holding out for higher levels might have proven costly as the exchange rate looks to have succumbed again to the familiar gravitational pull of €1.17.

Above: GBP/EUR at daily intervals, with the 1.1720 resistance line marked. Track GBP/EUR with your own custom rate alerts. Set Up Here 

Strategists at Citibank say they continue to fade Pound Sterling strength against the Euro as long as EUR/GBP remains above 0.85. (This equates to a Pound-Euro conversion remaining locked below 1.1765.)

"EUR/GBP broke through key support... around 0.8500 but bounced back rather quickly on short-term profit taking," says Brad W. Bechtel, who heads FX strategy at Jefferies Bank.

However, Citi's strategists "are willing to flip short if the break below 0.85 is sustained on a weekly/monthly close." This condition is proving elusive and could require more patience.

"We think EURGBP will break lower later this year and we target 0.84," says Thomas Flury, a strategist at UBS's Chief Investment Office. (EUR/GBP at 0.84 is 1.19 GBP/EUR).

Driving recent Pound strength is the rapid fading of expectations for a June rate cut at the Bank of England. Indeed, markets are now not even fully expecting a rate cut by August.

This is as the European Central Bank (ECB) is expected to cut interest rates this week, creating a clear divergence in monetary policy settings between the UK and Eurozone that favours GBP upside.

Because markets fully expect an interest rate cut at the ECB on Thursday, the decision itself won't be a market-moving surprise; what will move the market is the guidance pertaining to future rate cuts.

"The highlight is the ECB meeting, with a rate cut well anticipated, so the guidance for future policy moves will be a key driver. We think the euro will weaken, especially given its strong rally in recent weeks," says Dominic Schnider, a strategist with UBS' Chief Investment Office.

However, other analysts are wary that the ECB strikes a more 'hawkish' tone regarding the outlook, which can support the Euro. The Eurozone economy is rebounding, and inflation continues to prove sticky, suggesting there is little need to rush into another cut as early as July.

Expect the ECB to confirm that it remains data-dependent and argue that it is prudent to allow some time before cutting rates again.

This would be a status-quo outcome for the Euro and could result in further near-term strength as Eurozone bond yields firm, likely sending Pound-Euro back towards 1.17 again.