GBP/EUR Exchange Rate: February Forecast to be an Up-Month

Pound Sterling trades back above 1.17 against the Euro ahead of the all-important Bank of England event due at mid-day on Thursday, January 2.

We saw GBP/EUR jump notably on the first day of what we believe could well be a positive month for the GBP/EUR exchange rate.

Concerning the immediate outlook though (remainder of this week), we are actually neutral as both bullish and bearish signals on different timeframes offset each other.

The GBP/EUR rate peaked at 1.1817 on January 26 but then fell to a low at 1.1575 on January 31, it has since started to rebound but we are not breaking any fresh ground in the wider context:

However, because the monthly chart (below) is showing bullish potential we would be looking for stronger confirmation of a continuation lower, signalled by a break below the 1.1575 lows, before becoming outright bearish again.

A break below that, however, would lead to the next target lower at round-number support at 1.1500.

The bullish signal on the monthly chart shows a higher-than-expected possibility of February ending higher than it opened – i.e being an up-month.

Research suggests that when you have an up period - whether it be a day, week or month followed by two smaller down periods, the next period will see a resumption of the uptrend.

This fits with the GBP/EUR monthly chart which is showing a strong long-green up-month in November followed by two small, red down-months in December and January.

This indicates February will be an up-month, i.e green.

The pattern has about a 66% success rate and the same principle applies in bear markets.

Super-Thursday Looms, as Does a Potential GBP Rally

The most significant event for the GBP/EUR exchange rate in the remaining half of the week is the Bank of England (BoE) rate meeting on Thursday.

There is a chance of the Pound appreciating as the BOE will probably revise up their forecasts for growth and inflation, according to Capital Economics’ Scott Bowman.

Recent data showing strong consumption and stubbornly low unemployment means the BOE has more room to tackle rising inflation caused by the weak pound.

This, in turn, could lead to heightened expectations of the BOE raising interest rates, and Thursday is likely to show, at the very least, a change of stance from neutral to hawkish, which would propel Sterling higher.

Analyst Robert Wood at Bank of America Merrill Lynch argues that were the BoE to set interest rates on current growth and inflation data they would likely hike rates on Thursday.

But rate setters look forward to set policy. Given the weak Sterling they are still balancing a likely inflation overshoot against likely growth weakness.

So Wood expects a neutral bias on policy from the BoE, and expect them to hold rates and not extend QE this week.

But, the Pound could well benefit:

"We think the risks are skewed to a hawkish message. Carney will likely emphasize that there are limits to the BoE's inflation tolerance and conclude with a simple data watching position: steady as she goes for six months, but if growth does not slow then rate hikes will become more likely," says Wood.

Others agree.

We suggested getting tactically long GBP this week though we were stopped on a bout of GBP selling around Tuesday’s WMR fix," says Elsa Lignos at RBC Capital Markets. "GBP has since rallied hard and is up against all currencies; the levels are much less attractive for new longs but our bias is positive-GBP heading into today’s meeting."

Time to Bet on a Pound Recovery?

While the Bank of England will provide us with some steer it is worth remembering that sentiment surrounding Brexit remains key for the Pound's outlook.

Bank of America have told clients that they believe the Pound is nearing a long-term recovery phase.

"We believe that some of the traditional macro drivers for GBP, such as global growth and the UK housing and labour markets, are unlikely to be significantly impacted by the Brexit negotiations in the coming months. As a result, the divergences between these key drivers and GBP, which have built up as political risk premium has dominated price action, could be closed," says Kamal Sharma, FX Strategist at Bank of America.

Karma expects one final dip in GBP as Article 50 (A50) is formally triggered and as the EU formally responds and sets out its negotiating position.

"We think the crystallization of risks and the start of the countdown to Brexit may prove to be the low in GBP and the opportunity to enter GBP longs," says Sharma.

However, other analysts remain resolutely negative on Sterling's prospects and see little good news ahead for the Pound.

“It's strange to see GBP performing so well when the path towards a 'hard' Brexit remains firmly on the table; strategically, we remain bearish on GBP/USD and look for fresh catalysts (namely dollar strength) to see a short-term move back towards the 1.24 level,” says ING’s Viraj Patel.

Patel could be left frustrated as we see little by way of disruption to the Brexit story now that Parliament is likely to approve the triggering of Article 50.

We reckon the next big headlines will come as negotiations get underway and the cards are laid on the table.

This is some time away and Sterling could strengthen in the meantime.