British Pound to Remain Bid Vs Euro as Traders Turn Coy on Common Currency Ahead of ECB Meeting

Above: The ECB's Mario Draghi is in focus on Thursday. Markets will be wary of taking directional bets on the single-currency until his views are made clear.

Traders are seen taking profits on pro-Euro bets in order to guard against any disappointment that may come from the eagerly-awaited ECB meeting later this week.

The Pound-to-Euro exchange rate clung to recent gains Tuesday as traders continued to reappraise Sterling in the wake of last week’s European Council summit.

Bearish bets against the Pound have begun to unwind after October's European Council summit saw a more optimisitc and progressive tone adopted by leaders than traders had been expecting.

Meanwhile, the Euro is seen on the back-foot as traders view Thursday's policy announcement from the European Central Bank with caution.

“We are closing out our long EUR/GBP trade for a profit of +1.57%. Given the subtle shift in tone for Brexit talks and the importance of next week’s ECB meeting, it makes sense to remove risk now,” says Bipan Rai, a macro strategist at CIBC Capital Markets ahead of the week's trade.

A 'long' trade is one where traders bet an instrument will rise - in this case CIBC Capital Markets were anticipating the Euro to rise against the Pound.

Rai notes that trader sentiment toward the Euro is at a post-crisis high and positioning is heavily long the common currency. When positioning is heaviy one-sided, moves can tend to stall or even reverse.

Above: The Pound-to-Euro exchange rate is seen heading higher at the start of a week dominated by the European Central Bank.

“Trying to gauge EUR movements from here will be tricky. Consider, that the details of the programme have pretty much been leaked (with most expecting a 6-9 month extension and asset buying reduced to EUR25-35bln,” says Rai.

With markets well aware in advance of what the European Central Bank might announce this week, much of the eagerly awaited tapering is already priced into currency markets.

This means only a surprise decision to defer action or a more hawkish than expected taper would be needed to create significant volatility in prices.

“Tapering has now become a tactical theme to fade – especially as positioning and sentiment have become a risk. EUR bulls need fresh reasons to be long here, and for next week,” says Rai.

Rai’s comments, and current positioning of traders, also suggest that not only is the likely price reaction going to be difficult to predict, but there is little to be gained for those seeking to profit on Pound weakness against the Euro ahead of Thursday’s announcement.

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But Longer-Term, Pound is Still Vulnerable

That said, looking further out, CIBC Capital Markets reckon risks remain to the downside for the Pound relative to both the Euro and Dollar. Sterling is pricing a November rate hike as a near certainty while current pricing in the bond market also betrays some expectation of further action in 2018.

“Cracks are starting to emerge in the UK’s economic outlook, which the BoE won’t be able to ignore for long,” says Andrew Grantham, a senior economist at CIBC Capital Markets. “Because of the downbeat economic outlook, we expect Sterling to depreciate against both the Euro and US$.”

Grantham notes the slowdown in retail sales that has been observed in the UK over recent months and flags it as a cause for concern, citing the contribution of consumer spending to the economy.

“Meanwhile the BoE’s latest survey suggests that there’s been a significant reduction in credit availability to households already, even without the additional impact of higher interest rates,” says Grantham.

More Optimistic on the Pound

Semtiment towards Sterling, at least in some corners of the analyst community, continues to improve in light of the evolving Brexit story.

“Confirmation of a transition deal by the middle of next year is a key element of our bullish view, which is crucial in removing the cliff-edge risks associated with March 2019,” says Derek Halpenny, European head of global markets research at MUFG. “The news of a possible deal between Tory Europhile rebels and the Labour Party on certain amendments to the EU withdrawal bill could leave the government vulnerable to defeat."

The UK government has deferred a key parliamentary vote on the European Union Withdrawal Bill due to fears rebels within the ruling Conservative Party might ally themselves with the opposition Labour Party.

Concerns are that rebels want to tie the government’s hands around issues such as the single market, customs union and whether or not it will be permissible for the UK to leave the EU without a trade deal - the so called “no deal Brexit”.

“The power of parliament may well be coming to the fore now and only highlights the fact that the current parliamentary numbers are not in favour of a ‘Hard Brexit’ of any description,” says Halpenny.

Although it may seem trivial to the casual observer, proponents of leaving the European Union have expressed concerns about the rebel push because if successful, it will see British MPs force the UK government into accepting any “deal” offered by the EU - regardless of how good or bad it is.

Spanish Politics Yet to Harm the Euro, but that Might Change

For the Euro, it is not just the ECB event to keep an eye on this week as the Catalonia crisis continues to unfold.

The Euro fell against the Pound during early trading but pushed higher against the rest of the G10 bucket suggesting recent events in European politics are yet to deter the common currency.

On Saturday the Spanish government invoked Article 155 of the constitution and mandated the dissolution of the regional parliament in Catalonia.

Mariano Rajoy has staged a 'coup d’état' against democracy in #Catalonia > Op-Ed d'@A_RoyoMarine al @Independent. https://t.co/zZZ2oHEz5d

— Jaume Clotet (@jaumeclotet) October 22, 2017

Madrid has followed this with calls for new elections in response to the Northern Province’s continued push for independence and has urged Catalans to support the changeover at the top.

“Yesterday there was a coup d'état in full rule against the Catalan institutions,” says Jordi Turull, a spokesperson for the Catalan administration, on Sunday. The Catalan government now has two priorities, according to Turull, "the defense of the democratically elected institutions of Catalonia and the culmination of the mandate of October 1."

Turull’s statement appear to place the Catalan administration on course for a further clash with Spanish authorities in Madrid.

While the Catalonia crisis is yet to significantly alter the Euro's direction, such an eventuality cannot yet be ruled out.

“Madrid’s plan to impose direct rule in Catalonia is likely to be met by protests, which would cause short term disruption. The risk of a more serious economic deterioration is growing, but as things stand this is unlikely,” says Stephen Brown, an European economist at Capital Economics.

So while Catalonia makes for nothing more than intriguing headlines at present, be aware that any deterioration in the crisis could start to drive the Euro.