GBP/EUR Rate in U-Turn at Key Tech Barrier

The GBP/EUR exchange rate's recent spell of appreciation has ended at a key technical resistance level and the prospect for a deeper pullback now looks possible.

Sterling fell sharply in the mid-week session having hit a fresh two-month high against the Euro earlier on in the day having gone as high as 1.1902 - it's best rate in two months.

In doing so the exchange rate breached its 200-day moving average and was promptly met by a wall of sell orders which forced the currency into retreat.

The pair is quoted at 1.1779 on the morning of Thursday, February 23.

We wrote at the time that were the exchange rate able to cross the 200-day moving average in convincing fashion this would be a firm indication that Sterling's nascent recovery against the Euro, in place since late 2016, is becoming more entrenched.

Regarding the outlook, the failure to break above and hold the 200-day moving average could trigger a deeper sell-off. 

As we can see below, the Pound to Euro exchange rate has risen to meet the 200 day moving average which it has not successfully breached since December 2015:

Above: the 200 day moving average is denoted by the blue line. GBP/EUR tentatively broke above here on February 22, 2017.

If we look back towards 2013 we can see that the long-run rally often found support at the 200 day moving average over the course of ensuing months.

Then through 2016 the same level acted as a limit that any recoveries were unable to extend beyond.

This tells us that there are notable market orders lying around the 200-day MA as traders look to bet on either a rebound or rejection. Clearing out these orders requires a notable shift in sentiment, and we question whether now is the time for Sterling to break above the level.

These are early days yet for the recovery and which side of the 200 day MA the GBP/EUR exchange rate ends up on over coming days will clearly be important.

A failure here could well see Sterling sink deep back into its sub-1.18 range.

Analysts Fancy a Run Higher

Technical analyst Karen Jones at Commerzbank in London says she is now maintaining a negative bias on the Euro as its six-month uptrend has now been eroded.

Jones is targeting this year’s high at 1.1834 ahead of a potential move to 1.2042 which represents the December 2016 high and Commerzbank’s initial target.

The technical outlook aligns with the fundamental argument put forward by a number of institutional analysts who say the Pound has room to grow.

Analysts at Morgan Stanley this week told clients they were forecasting a potential recovery towards 1.25.

“GBP is currently undervalued and has stabilised, which we think offers a strategic opportunity to buy. In contrast, Eurozone political risks stay high as we get closer to elections. The ECB is unlikely to change its accommodative stance as inflation rates remain wide across the Eurozone,” says Morgan Stanley’s Hans Redeker.

“By far, Sterling is the most undervalued of G10 currencies, in trade weighted terms standing almost 20% below its long-term fair value,” notes Richard Flakenhall at SEB, the pan-Scandanavian investment banking and financial services provider.

However, Flakenhall is not yet ready to bet on a recovery in Sterling saying a slowdown in UK economic activity in 2017 will ensure it becomes even more undervalued ahead of a longer-term recovery to fair-value.

Why is the Pound Besting the Euro?

Quite simply, there is not much going on with the Pound at the moment - and that is a good thing for long-suffering Sterling bulls.

The economic data is quiet, yes recent data has been soft but still good in the long-term view.

Brexit is meanwhile discounted by a market resigned to the UK exiting the single market but likely to retain a decent amount of access to the market as would be expected if both sides act rationally, which they say they will.

The driver at present is therefore the Euro which is itself starting to absorb a good degree of risk now that the prospect of the anti-euro Marine Le Pen winning the French election is being taken seriously by markets.

The spread between French 10-year bonds and similar-maturity German bunds has risen to its widest in more than four years as markets reflect nerves.

Pound Sterling Live has reported this risk premium has been in the Euro and bond markets for some time now, but recent polls which show Le Pen making progress in the all-important second round of voting has exacerbated the situation.

A poll by OpinionWay for ORPI, Les Echos and Radio Classique shows the leader of the Front National has reduced the gap behind both Macron and Fillon in the second round of voting.
The poll showed Macron would defeat Le Pen by 58% to 42% in the second round. His advantage has halved in less than two weeks.

"It’s all about security. Le Pen is benefiting from the fact that they’re all busy either bickering or unable to disentangle themselves from their many controversies." A separate Harris poll showed that Le Pen is considered best placed to deal with security issues," says Bruno Jeanbart, director of OpinionWay.

Another poll for L'Express by Elabe shows Le Pen is now polling above 40% for the second round against both Fillon and Macron for the first time.

The same poll shows a recovery by Francois Fillon - the Republican candidate - against his rival Emmanuel Macron. As we note here, a Fillon win has positive conotations for Sterling longer-term on his views concerning how Brexit negotiations should be conducted.

Fears Le Pen will take France out of the EU, and thus potentially causing a political and economic storm in the region are depressing appetite for French debt and the Euro.

Beware, Markets Could be Overstating Le Pen Risk

Suggesting that markets might be over-egging the 'Frexit' risk that is a Marine Le Pen win is Lars Henriksson, an FX Strategist with Svenska Handelsbanken AB - the Swedish banking and financial services firm.

"It seems evident that she will lose the second round," says Henriksson, "therefore, a “Frexit” is highly unlikely. We are more worried about the state of the Italian banks as more banks are lining up for government support".

The problems surrounding Greece are also back on the table and it remains clear that this seemingly endless back and forth between a deeply dysfunctional Greek economy and its lenders will continue until the voters on either side say enough is enough.

Indeed, Grexit is arguably a more realistic outcome than Frexit.

Give, economic data in the Euro area is showing strength and is beating expectations at a pace we have not seen for almost two years.

"However, political uncertainty will limit the Euro’s potential for some time to come," says Henriksson.

UK Economic Data Undermines the Pound as Fears of Slowdown Grow

On the UK front the news has not been supportive for the currency.

The rejection at the 200 day moving average in GBP/EUR coincided with the release of a UK GDP revision for the fourth quarter 2016 that showed business investment fell 1%.

This suggests uncertainty surrounding the UK's future relationship with Europe could be holding back investment decisions.