5-Day GBP/EUR Exchange Rate Technical Forecast, Key Data to Watch + Fresh Brexit Negotiation Scenarios to Consider
Above: UK political newsflow increases in tempo over the coming week.
Out technical studies suggest the Pound to Euro exchange rate (GBP/EUR) has potentially bottomed and may be starting to consolidate above recent eight-year lows.
The Euro lost ground on news the European Central Bank (ECB) may delay an announcement on the winding down its quantitative easing program untill December and markets will likely remain cautious on the single-currency heading into Thursday's policy meeting.
U.K. data meanwhile appears to be picking up pace once more and this week's data releases will be key in confirming whether the tempo is indeed improving.
Meanwhile, E.U. Brexit negotiator Michel Barnier's comments that he is seeking to "teach" the British "a lesson" for voting to leave the E.U. poses some interesting questions for the Brexit story, something we reflect on in more detail further on in this report.
Improving Technicals, but too Early to Call All-Out Recovery
Looking at the charts - Sterling bulls are cautioned not to get too carried away despite a vastly improved technical outlook as the week brings further major political risks for the currency.
We note how the August 29 lows are looking increasingly like a key turning point for the pair; as in the days since the exchange rate has moved rapidly higher in a strong rebound.
The strength of the recovery alone suggests it won't end here and we see a high chance of an extension.
A tough obstacle to further gains may come in the form of the monthly pivot (PP) just above the current market level at 1.0937.
Monthly pivots are used by traders to gauge the trend and as places to fade the dominant trend since the exchange rate often bounces or pull-back from them.
For a continuation higher, therefore, we would ideally wish to see the pair completely clear the 1.0937 level, which would be confirmed by a move above the 1.0975 level.
The next major resistance level is at the trendline (A) in the mid 1.10s and our next upside target is at 1.1025 since it is not known whether the exchange rate will be able to break above the trendline successfully.
The MACD momentum indicator has crossed its signal line producing a bullish signal.
The MACD looks like it will probably continue rising, but it is still below the zero-line indicating the dominant trend is still down according to the indicator.
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Euro Enjoying a Safe-Haven Status
The Euro exchange rate complex is seen rising at the start of the new week morning as it appears to have reverted to its old relationship with global sentiment, a relationship in which it gains during crises, like the Swiss Franc and gold.
Pyongyang's increasing provocation - most recently with the testing of an H-bomb over the weekend - has led to investors pulling out of risky investments and seeking safer-havens instead. The testing of the bomb is the latest in the escalations of tensions surrounding North Korea which is adopting an increasingly aggressive stance towards its neighbours and the United States.
This has benefited the Euro which has become a favoured funding currency for risky investments due to its record low-interest rates, which essentially mean investors can borrow for next to nothing and invest the proceeds in high yielding riskier projects abroad.
Geopolitical fears brought those investments 'home' on Monday as investors unwound their riskier plays and repatriated their Euros, leading to a rebound in the single currency.
Analyst Petr Krpata at ING Bank N.V. in London notes the Euro's growing "safe haven properties" while noting the US Dollar "is falling in the pecking order of safe haven currencies within the G10 FX space."
The Euro to Pound Sterling exchange rate (EUR/GBP) rose to 0.9185 from Friday's close of 0.9157.
The Euro to Dollar exchange rate (EUR/USD) also rose to 1.1894 from Friday's 1.1859.
We do expect the Euro's advance to be contained however ahead of Thursday's European Central Bank meeting.
Just how serious North Korea is regarding the use of weapons and pushing the envelope ever further is also questionable.
"The impact on the risk sentiment may not to be long lived. This was the case last month and with risks now being well known, we are likely to observe a diminishing effect of the headline news on global markets," says Krpata.
Heavy Week of Data for Sterling
On Monday, Construction PMI for August is out at 9.30 BST, and on Tuesday Services PMI are out at the same time.
PMI's are surveys of purchasing managers and provide a snapshot of how conditions are in a particular industry sector.
A score of over 50 indicates expansion and under 50 indicates contraction.
Construction is forecast to come out at 52.0 in August from 51.9 in July, and Services at 53.5 from 53.8 in July.
On Tuesday, Eurozone Services PMI is out at 9.00 BST - half an hour earlier than UK PMI - and research shows that if one goes one way and the other goes the opposite way, it causes a volatile move in GBP/EUR.
The data comes in the wake of PMI data for the manufacturing sector which registered at a three-year high and suggest economic activity is lifting following an uninspiring first-half to 2017.
Markets will be looking for confirmation that the pick-up in activity is extending, particularly into the all-important services sector which accounts for in excess of 80% of UK economic activity.
Friday, September 8, sees the release of Industrial and Manufacturing Production for July, at 9.30 BST. This provides the official insight into whether manufacturing numbers are indeed picking up. Note that they are a month behind the PMI data.
The former is supposed to show a 0.2% rise and the latter a 0.3% rise.
The Trade Balance in July is out at the same time, and is expected to show a narrowing of the deficit to -11.9bn from -12.72bn previously. Sterling remains hindered by this deficit which is the result of the UK importing more than it exports.
The data will provide insights as to whether the fall in value in Sterling has allowed for a pick-up in exports. While exports are on the rise, the extent of improvement has failed to impress. However, some economists warn that there is always a long lag before the currency impact hits activity. We will be looking for such confirmation.
Thursday, September 7 witnesses the release of Halifax House prices in August at 8.30 BST.
Politics: E.U. to Make an Example of the U.K.
Image (C) European Commission.
While the data calendar hots up over coming days, politics will never be far away as a driver of Sterling.
Concerning headlines over the weekend have confirmed what many in the U.K. fear: the E.U. intends to make an example of the U.K. for its decision to exit the E.U. with chief negotiator Michel Barnier stating negotiations offer an opportunity for the E.U. to "teach the British people and others what leaving the EU means".
Barnier told a conference in Italy on the weekend that while he did not want to punish the U.K. for leaving he did confirm Brexit would serve as an "an educational process" for the British.
"I have a state of mind - not aggressive... but I'm not naïve," Barnier told the Ambrosetti forum. "There are extremely serious consequences of leaving the single market and it hasn't been explained to the British people. We intend to teach people… what leaving the single market means."
This confirms our view that the E.U. are in fact not in the mood for negotiating; rather they are placing a prescribed set of conditions down before the U.K. which must be accepted, or no deal will be granted.
Brexit negotiations have now passed three rounds, with some progress being made but the E.U. are keen to make it known that none of their initial objectives - particularly on receiving a payment of ~€100BN from the U.K. on its exit from the Union have yet been agreed.
Until the E.U. greenlight the first rounds concerning the technicalities of exit, they are not willing to discuss trade. This leaves Sterling prone to the risk that a disorderly exit takes place.
The big question we are however asking is whether or not Sterling fully reflects such a disorderly Brexit. If it does, then presumably the currency will become increasingly immune to negative newsflow concerning the negotiations. If not, then substantive downside must be negotiated.
Another question to ask, from a currency perspective, is how will dynamics change were the E.U. to be exposed as simply seeking to punish Britain, how does this impact on internal E.U. politics, particularly for countries such as Ireland and the Netherlands which rely heavily on their exports to the U.K?
German manufacturers also rely heavily on the U.K. market and one would expect a clash of economic interests and the political ideology as pushed by Barnier, Juncker and Verhofstadt.
Can pragmatism push the E.U. into a friendlier approach? If the answer is yes, it would certainly benefit Sterling.
Another question for those trying to anticipate the direction of politics and Sterling is to consider whether comments of "educating" the British sit well with the British people?
We saw how Theresa May found a rise in support on her robust response to Jean-Claude Juncker after he labelled her a difficult woman following a dinner in Downing Street. Voters tend to respond well to those defending them, and this might be the case should a seige mentality be established on the back of a daily barrage of warnings and threats from the E.U.
We would suggest that the Government's position on Brexit, and the Conservative Party by extension, might find some support were they to be seen as standing up to the E.U. and having a more flexible approach to negotiations.
And a more secure hand for the Conservative Party would play well for Sterling as a fragile Government makes for uncertainty, and the Pound hates uncertainty.
The prospect of five years without another uncertainty-inspiring vote will be welcomed.
News, Data, and Events for the Euro
The main event for the Euro is the European Central Bank (ECB) rate meeting on Thursday.
This could prove a volatile event for the Euro as the ECB is expected to comment on when and by how much it is going to reduce its bond purchase program - or QE as it is more familiarly known.
Back in June, the governing council said it would discuss exiting the program in "the fall" and market participants have taken this as meaning possibly September; probably October.
The program is officially set to end in December, but analysts now think the ECB will extend it well into 2018 if not 2019.
The main reason for expecting an extension is the strong Euro which is likely to weigh on inflation by making imports cheaper.
Analysts at TD Securities think the ECB will substantially revise down their inflation forecasts at the September meeting and use that as a reason to extend QE.
"We look for forward guidance unchanged, and substantial downward revisions to the 2018-19 inflation projections due to the stronger EUR, but with no explicit push-back against EUR strength," said TD, who added that in the press conference after they think Draghi will hint at an extension of QE into 2018:
"We think that Draghi will point to low inflation to suggest that the end of QE is still some ways off, with no specific end date in mind, leaving a dovish tone. Anything that points to a more specific end date would be hawkish."
Robust economic growth reflected in a recent run of positive data combined with comments from two ECB officials downplaying the strong Euro, however, suggest there is still a chance the ECB may be keen to wind down stimulus, which is rising to an astronomical 4.5trillion.
"The issue limits are going to force them to exit prematurely. They cannot duck the consequences indefinitely," commented Richard Barwell of BNP Paribas, in reference to the unprecedented size of the ECB's balance sheet and the financial risks they might be storing up.