The Pound-to-Euro Rate Week Ahead Forecast: 1.15 Possible?

The prospect of a move into the 1.15s is becoming increasingly probable, but much will depend on wage and GDP data due for release in the coming week. 

The GBP/EUR exhcange rate has successfully held ground above 1.13 following a 0.75% advance in the previous week and our studies suggest it might be forming a base from which it can successfully assault the highs of its longer-term range.

It appears Brexit risks are easing while the UK economy is expected to continue showing its trademark resilience. 

Our technical studies for the Pound-to-Euro exchange rate forecasts further upside in the longer-term, but patience must be exercised as near-term we are likely to remain within recent parameters.

GBP/EUR's current range lies roughly between 1.1100 and 1.1500 (see chart below).

The range may well be coming to an end and a breakout could follow.

Trading ranges are usually composed of five waves which means the one on GBP/EUR may well be close to finishing as it appears to have completed the fifth wave or component wave 'e'.

Now that 'e' is complete we expect the exchange rate to move back up towards the range highs at 1.1500 and then breakout of the range to the upside.

The reason we expect a breakout higher rather than lower is threefold.

First, the short-term trend immediately prior to the formation of the range was up and this marginally advantages a breakout higher.

Second, a breakout higher looks like a more natural evolution purely from a visual perspective, whereas a breakdown would just not look 'right' somehow.

Thirdly, the lows and highs of the range have steadily risen as it has evolved showing buyers have the advantage and therefore favouring an upside breakout.

A clear move above the 200-day moving average and the twin highs formed on the 9th and 18th of Jan in the 1.1360s, confirmed by a move above 1.1375, would signal a probable continuation with the range up to the 1.1500 highs.

A subsequent move above the wave 'd', December 8, highs at 1.1510 would confirm a breakout to the upside, to an initial target at 1.1600, just below the R2 monthly pivot.

Monthly pivots tend to exert downward pressure on rising prices due to traders targeting them as levels to short-sell.

A clear break above R2, confirmed by a move above 1.1630 would signal a continuation up to a final target at 1.1730, calculated by taking the 61.8% of the height of the range and extrapolating it higher - a tried and tested method for establishing a minimum target after a breakout.

61.8% is related to the 'golden mean' which is the ratio 0.618 which mathematicians have found governs proportional relationships in many natural phenomena from the distribution of sunflower seeds to the whorl on sea snail shells - and reputedly waves of buying and selling in financial markets too.

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Data and Events to Watch for the Pound

Two big releases really stand out for the Pound next week: Employment data and fourth quarter GDP.

Employment data for November is out on Wednesday at 9.30 GMT and is forecast shows the unemployment rate staying fixed at 17-year lows of 4.3%.

Wages are also likely to be in focus as they influence inflation which in turn influences interest rates and hence Sterling.

Higher wages, equal higher inflation, equals higher interest rates, equals higher Pound.

Wages rose by 2.5% in the previous month of October compared to a year ago and are expected to rise the same in November.

Unfortunately for workers this is a half a percent below inflation at 3.0%, which means they are essentially getting poorer.

This suggests consumption may fall as people tighten their belts which will reduce growth.

Evidence of wages rising in December, however, from a new survey conducted by IHS Markit suggests a possibility of an upside surprise in Wednesday's earnings data, although the official data will be for the month before the IHS Markit data.

The other major release in the week ahead is Q4 GDP on Friday at 9.30.

Consensus estimates are for GDP to equal 1.4% in Q4 from 1.7% in Q3  reflecting the slowdown in the economy due to the corrosive effects of high inflation and businesses holding back from making investment decisions due to Brexit uncertainty.

A fall to the estimated 1.4% would mean the annual growth rate on a quarterly interval comparison basis will have fallen to lows not seen since 2009 - over eight years ago during the financial crisis.

(Image courtesy of tradingeconomics.com)

The quarterly rate, however, is forecast to remain at 0.4% like Q3, and the year-on-year data may reflect a more negative situation than the quarterly figures suggest.

The economy has shown and will continue to show resilience when GDP data is released, says IHS Markit Economist Bernard Aw.

"Preliminary estimates of UK GDP for the fourth quarter are eagerly awaited for confirmation that the economy continues to show resilience on the face of Brexit uncertainty," says Aw.

From a growth perspective the outlook may be improving after recent concilatory comments from French President Emmanuel Macron and other leading EU figures suggested the UK could have a bespoke trade deal after Brexit, and consquently a  softer-landing for the UK economy. 

Data and Events for the Euro

The main event for the Euro in the week ahead is the European Central Bank policy meeting at 12.45 on Thursday, in Frankfurt.

No change in policy is expected at the meeting but the market is alert to possible changes in the bank's 'forward guidance' or in layman's terms its message on how it expects its policies to evolve in the future.

This is due to certain passages in the previous meeting minutes which suggest a significant proportion of the ECB governing council think forward guidance needs to be updated near the beginning of 2018, although most analysts think this means the

March meeting, not January - and this has been backed up by unnamed sources at the ECB.

Yet given the ECB's market preference for making changes very gradually there may be a few tweaks in the language of the

January statement too, and these could move the Euro, especially if they indicate optimism in the economic outlook, as this will suggest a speedier end to the ECB's emergency QE programme, which is overall a negative influence on the Euro.

The other major focus for the market will be whether the ECB's statement or Mario Draghi in the live press conference afterwards mention the strength of the Euro, which has risen by 13% (versus USD) in under a year.

An overly strong Euro will dampen inflation by lower the price of imports and therefore essentially act contrary to the goals of the ECB which is to raise inflation back up to its just-below 2.0% target.

Three members of the governing council have already expressed concerns about the strength of the Euro in the last week and investors are now speculating as to whether the ECB will try to use verbal intervention to talk it down on Thursday.

One issue is that not all the governing council feel the same way about the Euro being over-strong.

France, for example, is at one pole in that it would prefer a weaker Euro because of its own French problems but Germany is that the other and see's no problems in the Euro's current exchange rate - thus the rising Euro has the potential to spark a rift with the ECB, and perhaps because of this Draghi will be mindful not to take sides and try to avoid direct answers on the subject.

Finally, it is also worth remembering that the Euro is much stronger against the US Dollar than versus a combine basket of counterparts against which it has risen much more modestly, and is only 2.0% above the assumptions made in the ECB's staff macro-economic projections published at the December meeting, whereas EUR/USD in comparison is substantially higher now than the assumption of 1.17 in the projections.

The Euro's strength is therefore not broad-based.

Other key data from Europe in the week ahead include Manufacturing and Services PMI data for January out at 9.00 GMT on Wednesday.

This is survey data from interviews with Purchasing Managers in the industry sectors covered and provides a normally very accurate picture of activity levels.

Manufacturing reached a survey history high of 60.6 in December and is forecast to moderate to 60.3 in Jan; Services is expected to slide to 56.4 from 56.6.

The ZEW Investor Sentiment survey on Tuesday completes the major releases for the Euro in the week ahead.

Economic Sentiment in Europe is forecast to rise to 30.0 from 29.0 in January by ZEW.

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Traders Increasingly Optimistic on Sterling

Sentiment towards the British Pound continues to improve which suggests potential for further gains over coming weeks and months.

Last week again saw global currency market participants once again boost their 'long' exposure to the Pound - i.e. more traders are entering and holding trades that seek to benefit on an appreciation in the UK currency than there are entering and holding trades that seek to benefit on a decline.

Available weekly data on trader positioning at major institutions confirms an ongoing trend away from positioning for the Pound to fall into bets for the Pound to strengthen. The move suggests the market place reckons the worst could now finally be behind Sterling and the recent recovery might have further to run.

"In the week ended 16 January, leveraged funds increased GBP net longs from 30% to 39%, the highest level since the EU referendum. On the other hand, asset managers’ net short position in GBP was reduced from 40% to 33%," says Bilal Hafeez at Nomura.

Nomura point out that GBP long positioning has now risen to a post-Brexit high.

The findings at Nomura are echoed by those of French multi-national banking giant BNP Paribas who now report a moderate build up of long GBP positions. "FX funds appear to have cut back large GBP short positions," says Natalie Rickard, FX Strategist with BNP Paribas.