Pound / Euro Exchange Rate Could be Set to Decline to 1.36

The British pound sell-off against the euro took a dramatic step when it broke below the 1.40 level mid-week.

1.40 was seen by us as a reliable source of support that would dictate direction in the near-term as we saw little signs that the pair could trade below this level on a sustainable basis.

The pound to euro exchange rate (GBPEUR) is now seen in the middle of its 2015 trading range at 1.3899.

A negative bias is maintained from a technical perspective owing to the momentum to the downside seen over the past four trading days and we would suspect that the market is intent on pushing the currency pair towards the bottom of its range.

We could well see GBP-EUR head towards initial support at 1.38 ahead of a further breakdown towards 1.36.

While the spot markets quote just above 1.3890 we note quotes from high-street banks converging around 1.3502 for international payment requests. 

The best independent quote we are seeing is much closer to the market just above 1.3720.

Why is the Euro Stronger?

With the ongoing crisis concerning Greece many casual currency market watchers would  rightly be shocked to see the pound sterling performing so miserably against its Continental peer.

We have told readers throughout this long and wearisome saga that losing sight of the fundamental drivers of euro valuation should be guarded against.

The German economy is central to the euro’s valuation; remember Greece accounts for less than 2% of Eurozone economic output.

So when German bund yields (yield on German government debt) rose mid-week we saw the euro exchange rate complex move higher alongside.

The euro is positively correlated with German bunds - when they go up so does the euro.

Nevertheless, we have seen GBP-EUR spike higher whenever negative events come out of Greece.

With a full EU summit expected on Sunday, time is running out for Athens to win support for a new deal.

“Interest rate differentials moved in favour of the euro yesterday, but this might change if sentiment on risk turns positive. Of course, uncertainty on Greece isn’t over yet. Markets will look out for the Greek reform proposals. This is again a binary risk. Almost everything is possible,” says Piet Lammens at KBC Markets.

If no deal is done by next Monday, a Grexit looks probable. But we would suggest those with currency requirements on the euro act fast on any spikes. The general response by the euro has been to rally strongly once the bad news has been digested.

Indeed, we continue to see a strong appetite from US investors for euros. That the currency often recovers when US markets open is no coincidence.

For now the correction of sterling could well continue. UK data were not to blame, indeed the BRC shop prices ‘improved’ from -1.9% Y/Y to -1.3% Y/Y and the Halifax house prices rose 1.7% M/M and 9.6 Y/Y (0.3% M/M and 8.6% Y/Y was expected).

In addition to German bund strength further reason for the GBP’s poor performance of late could be position changes amongst foreign exchange investors.

The pound has been one of the best performing currencies on a cumulative basis and UK finance Minister Osborne’s post-election budget might have been an excuse to offload some GBP long positions.

The profit-taking could continue for some time but longer-term we remain confident that the UK’s strong economy will prompt the GBP higher.