Pound Boosted by Stock Market Recovery BUT the Euro is Still the Horse to Back

The British pound entered the weekend looking more constructive as stock markets bounced higher. Looking to next week, what will drive the pound, and could we see better levels?

The respite should not be mistaken for the start of a major recovery for sterling-euro; there is simply nothing on the dashboard to indicate this as being the case.

As such, we must assume that this is a spike in a broader downtrend and those with EUR payments should act.

Against the US dollar we are a little more constructive though noting that there remains the prospect for a test of 1.46 with our mid-week analysis remaining valid.

The pound to euro exchange rate is at 1.2870 on the spot markets, banks offering a rate between 1.25-1.60 in our estimation while quotes from independent providers are noted at 1.27.

The pound to dollar exchange rate is at 1.45, up from last night's close at 1.4475, bank transfer rates are at about 1.45 based on historical spreads while independents will look to quote above 1.43.

So what matters for GBP? It depends who the currency is trading against. If we are talking about GBP/EUR then watch stock market action, if it is GBP/USD then watch to see if the February slump in the US dollar family has further to extend.

Let’s look at GBP/EUR first.  

Stock markets are firmer, the buying of stocks has ensured that euro-supportive money flows are easing off. This would reverse when stock markets are sold off though as investors look to pay back into euro bank accounts from which they borrowed cheap euros to fund investments.

The demand for German sovereign debt also spikes in times of worry with this asset class being regarded as a true safe-haven. Equities officially entered a bear market yesterday with the MSCI All Country World Index now down 20% from its peak last May.

The gloom comes on the back of slowing growth and corporate profits combined with a sense that central bankers may be close to reaching the limits of monetary policy support.

“Things were shored up this morning by a solid set of figures from the Eurozone. Coming in as expected at 0.3%, the avoidance of any nasty surprises in the preliminary German fourth quarter GDP figure appears to have lifted investors’ spirits somewhat, allowing the DAX to start the day around 1.2% higher,” notes Connor Campbell at Spreadex.

Interesting! We get good data out of the Eurozone yet the euro falls. This echoes the rise of sterling on Wednesday in the face of poor manufacturing and industrial production data.

The bottom line is global drivers now matter.

Also aiding the move higher in stock markets was German giant Commerzbank, up nearly 14% after the bell, having provided some banking sector reassurance with an investor-pleasing Q4 report.

“Add onto that a better than forecast set of French non-farm numbers and the CAC could join its German peer, rising 1.4% after the bell. If the Eurozone-wide Q4 GDP figure can similarly avoid upsetting investors the region just might manage a much-needed day-long rebound this Friday,” says Campbell.

Nevertheless, we favour the euro against the pound. “EUR/GBP remains on target for .8030/50, this is the
measurement higher from the base .7492-.6937 it is also a Fibonacci retracement and we would expect to see initial failure in this vicinity,” says Karen Jones, technical strategist with Commerzbank.

All Eyes on Brexit Summit, Inflation Data Next Week

UK Prime Minister David Cameron takes his UK-in-Europe compromise to other EU leaders this week, hoping to convince them it doesn’t give the UK too special a status in the union, while hoping to convince the British public that it does.

GBP is likely to see sharp swings on rumours as the meeting gets underway.

Acceptance by other leaders should mean a June 2016 referendum.

We also have inflation data out of the UK - higher-than-expected data here could prompt a strong upside reaction in the GBP.

Indeed, the pound will likely be more prone to the upside on good news owing to just how negative sentiment against the currency is at the present time.

Markets are forecasting a reading of 0.3% in the headline annual reading and 1.3% in the annual core reading.

But, TD Securities warn there could be more disappointment:

"Nothing in January suggests a monthly firming in prices, unless GBP weakness passed through to prices more rapidly than usual. Instead, we see myriads of reasons for somewhat weaker prices on the month, including a snapback in airfares, which had boosted the December number."

The GBP to USD: What Counts?

The US dollar has been in decline of late with the USD index (DXY) falling in the past 12 of 14 trading sessions. You don’t need a graphic to tell you what the near-term trend looks like.

The dollar has been falling since data out of the US in early February was shown to be well-below trend.

This got markets thinking that interest rate rises at the US Federal Reserve could be put on hold.

Indeed, this was more or less confirmed by the Fed chair Janet Yellen’s testimony to Congress this week which focused strongly on the recent tightening of US financial conditions.

Unless conditions ease soon, the Federal Reserve may delay tightening policy further in line with the market’s view of a pause in rate hikes at the March FOMC meeting.

“Somewhat ironically, it is the USD’s appreciation that has been the main cause of the tightening in financial conditions and the impact of policy may, in turn, prevent further near-term USD appreciation. In our view, it may take some time for US financial conditions to loosen and, as a result, rate hikes and USD appreciation may stall,” says Steven Saywell at BNP Paribas in London.

We thus see scope for the GBP/USD to push higher. Markets are negatively positioned against the pound with short-trade bets at levels not seen since 2008.

This means that any recovery could really have legs if these positions are unwound.