- GBP gains 2.34% on EUR but nears resistance on the charts.
- GBP gains could slow but it retains the initiative above 1.1633.
- And could target April 2016 high once through the 1.2137 level.
- But raft of key economic figures to put spotlight on BoE outlook.
- Jobs, inflation, retail sales and PMI data all due in week ahead.
- EUR also faces key economic data amid bearish outlook on charts.
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The Pound-to-Euro rate rose sharply last week as Sterling moved back into the black against the single currency for 2020 but exchange rate is nearing technical resistance on the charts and economic data is due to test appetite for the British currency in the coming days.
Pound Sterling was the best performing major currency last week, rising by more than two percent against the Euro, after the appointment of Conservative Party MP Rishi Sunak as Chancellor lifted expectations for growth, inflation, interest rates and the currency in the months ahead.
Those expectations were reflected by increases in British government bond yields, which led the Pound higher against all rivals throughout last week.
Sunak's appointment was seen heralding greater agreement, if-not consensus between the PM's office and treasury when it comes to joint decisions over government spending plans. And as a result, investors are banking on a larger stimulus being delivered in the March 11 budget than was previously imagined.
"After the multi-month upward trendline supported last week, GBP/EUR has now clinched fresh 9-week highs and retains its bullish stance. The next upside test could be €1.2080 (post-general election high), €1.21 (psychologically important) and €1.2190 (a long-term retracement) may then act as a magnet. However, the last three years shows us that GBP/EUR hasn’t held above €1.20 for long," says George Vessey, a strategist at Western Union.
Above: Pound-to-Euro rate shown at 4-hour intervals alongside 2-year GB bond yield (orange line, left axis).
Analysts are divided on what this could mean for the Pound in the short-term although it's January economic data, which is also important for the ever-evolving outlook for interest rates at the Bank of England (BoE), and technical factors that are in the driving seat this week.
The Pound broke above a technical resistance level at 1.1933 last week and after climbing through the 1.20 threshold it now faces a number of other obstacles ahead of it.
Western Union's Vessey flags 1.2080, 1.21 and 1.2190 as notable levels at which the Pound might find its upward momentum beginning to ebb, which is unfortunate for Sterling because it starts the week knocking on the door of those levels. Others are watching the 1.2137 level with interest.
"EUR/GBP has sold off aggressively eroding key short term support," says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank. "This leaves it severely under pressure."
Jones says Sterling is on course to test 1.2137 and that if this gives way then it could aim for 1.2244, which would be the highest seen by the Pound-to-Euro rate since April 2016, months before the fateful Brexit referendum.
She says momentum will remain with Sterling so long as the Pound-to-Euro rate is above 1.1619 and has told clients to bet on renewed upward move if the exchange rate happens to pull back to 1.1926-to-1.1983 area.
Above: Pound-to-Euro rate shown at daily intervals alongside 2-year GB bond yield (orange line, left axis).
Pound Sterling: What to Watch
The Pound was last week's best performing major currency but sustaining that performance through the week ahead will be a tall order given that a raft of key economic figures are set to put the Bank of England back in the spotlight.
Pound Sterling was buoyed last week when markets saw the appointment of Conservative Party MP Rishi Sunak as Chancellor heralding greater agreement, if-not consensus between the PM's office and treasury when it comes to joint decisions over government spending plans.
The appointment has gotten investors as well as Pound Sterling banking on a larger fiscal stimulus being delivered in the March 11 budget than was previously imagined, which is expected to lift economic growth, inflation, interest rates and the Pound in the months and years ahead.
But some in the market say that Sterling and its newfound backers have gotten ahead of themselves.
"While we would expect some fiscal stimulus, it’s unlikely the government will want to use all of its ammunition with the next election so far off. In turn, markets may receive little indication to endorse such expectation next week which may fuel a correction in GBP," says Chris Turner, head of FX strategy at ING.
Pound Sterling narrowly escaped an interest rate cut in January after the BoE opted to wait and observe the performance of the economy in January and as a result, markets have reduced the assumed probability of a rate cut coming in the first half of 2020, but that assumption will be tested this week.
Tuesday at 09:30 will bring January jobs data and the Pound would be unlikely to take kindly to any perceived deterioration in the outlook for employment. Consensus is looking for the unemployment rate to remain at 3.8% but for the annualised pace of wage growth to have dipped from 3.2% to 3.1%.
"Our short term indicators continue to point to some upside pressure for unemployment, which we think could crystalise by summer," says Sanjay Raja, an economist at Deutsche Bank. "We expect inflation to track below the Bank's forecasts through Q1, raising more concerns for the MPC as we head into Spring...we expect retail sales (ex-auto) to rise by a pretty sizeable amount (1.2% m-o-m), which would mark the largest single month increase in nine."
Any increase in unemployment, or meaningful decline in wage growth, would undermine the outlook for inflation, interest rates and the Pound.
And inflation already fell sharply at year-end, from 1.7% to 1.3%, leaving it even further below the 2% target of the BoE.
Wednesday at 09:30 will see January's consumer price index released and markets are looking for the inflation rate to have returned to November's 1.7% level with the more important core inflation rate also seen retracing at least some of its earlier decline. Core inflation is seen rising from 1.4% to 1.5%.
"The flurry of data releases will further reduce expectations of an interest rate cut this year by showing that the labour market stayed healthy in December (due Tuesday), inflation rebounded in January (Wednesday), retail sales bounced back in January (Thursday) and the upturn in the activity PMIs continued," says Paul Dales, chief UK economist at Capital Economics.
Pricing in the overnight-index-swap market implied on Friday an August 06 Bank Rate of 0.59%, which is below the current 0.75% but still meaningfully above the next level down of 0.50%. In other words, there's both upside and downside risks for Sterling from any changes in market expectations for interest rates.
Those expectations will evolve in response to the jobs and inflation data but retail sales figures for the month of January and the IHS Markit flash PMI surveys of the manufacturing and services sectors for February will arguably say more about the outlook for inflation and interest rates.
"We look for total retail sales to rise by 0.3% over the month and for the ex-fuel measure to increase by 0.4%," says Philip Shaw, chief economist at Investec. "We are pencilling in a half point drop in the UK manufacturing PMI to 49.5. For the UK services PMI we look for the PMI to stand at 53.4."
Markets are looking for 0.7% gain in UK retail sales to have reversed a 0.6% decline from December when the January data is released at 09:30 Thursday.
Those figures will be important to the BoE outlook because they'll speak volumes about the New Year state of the consumer, which has been a linchpin of the economy in recent years.
Even more important are the IHS Markit PMI surveys of the manufacturing and services sectors due out at 09:30 on Friday because they'll provide a number of insights about the current state of the economy and the outlook for it.
"Should a steady or extended bounce in the PMI not be validated, the market may be inclined to return to pricing modest easing back into the OIS curve in H1-2020, leaving GBP on the defensive," warns Mazen Issa, a strategist at TD Securities.
PMI surveys will reveal the extent to which the outlook has been burnished by the UK's orderly exit from the EU into a transition period on January 31 and the 'phase one deal' between the U.S. and China, which has at least temporarily ended the trade war between the world's two largest economies.
And they'll also provide clues about the impact the coronavirus might have on two of the UK's most important business sectors over the coming months.
"A key question for the upcoming ‘flash’ February PMI is whether it will paint a picture of an economy experiencing some renewed downside influences as a result of the new coronavirus," Shaw says. "There remains significant uncertainty over how big and how persistent a blow the global economy will be dealt as a result of the coronavirus (Covid-19). We suspect that some of these concerns will start to spill over into sentiment, particularly for manufacturers."
The Euro: What to Watch
The Euro was the worst performing major currency last week after bearish technical factors conspired with an increasingly bleak continental economic outlook to force Europe's unified unit to fresh multi-year lows against the Pound and Dollar, and there could be only limited respite in store for the week ahead.
Europe's single currency fell to new post-referendum lows against the Pound and ceded more ground to a still-mighty Dollar, with bearish charts egging on a downward lurch that was first incited by bad industrial production data.
And this week could bring only limited, intermittent respite because charts are warning of a new multi-year low being in the pipeline while Tuesday brings the next German ZEW survey and Friday will see IHS Markit release its latest PMI surveys of the long-suffering manufacturing and services sectors.
"The result may be another leg lower in EUR/USD as market extend their expectations that the ECB will keep rates on hold for longer," says Chris Turner, head of FX strategy at ING. "All in all, we see the balance of risks still tilted to the downside for the euro next week."
Tuesday marks the release of the influential ZEW economic sentiment survey for January, a composite of more than 300 analyst views on current economic situation and the outlook for growth in Europe's largest economy.
Markets are looking for the ZEW barometer to fall from 26.7 to 20.0, before attention shifts to Friday's PMI surveys.
Consensus is looking for only miniscule declines in the manufacturing and services PMI indices this week and likewise with the equivalent barometers for Germany and France, which will scrutinised closely by investors and the Euro. Expectations are for the Eurozone manufacturing PMI to fall from 47.9 to 47.4 at 10:00 Friday, while the services PMI is seen falling from 52.5 to 52.4.
Germany's manufacturing PMI is seen falling from 45.3 to 44.8 in what would be only a modest movement for even an ordinary month and January was no ordinary month for the global manufacturing sector, which experienced significant disruption in the final week as China's economy went into 'lockdown'.
The German services PMI is seen declining from 54.2 to 53.9 while the equivalent French barometer is expected to rise from 51.0 to 51.4. France's manufacturing PMI is seen falling from 51.1 to 50.8 when the individual country figures are released between 08:15 and 08:30 on Friday.
"While the euro has already fallen to its lowest level in nearly two years against the US dollar, we think that it will drop a bit further during the rest of 2020, pushed down by several factors including a weak economic outlook and looser monetary policy," says Hubert de Barochez at Capital Economics.
Expectations for the Euro's performance in the year ahead were dented last week by data revealing the German economy stalled on 0% growth in the final quarter, which comes barely more than a week after other figures showed the French and Italian economies contracting into year-end.
Eurozone growth was just 0.1% in the final quarter as a result of the weak performance from its three largest economies.
They underperformed in spite of a marked de-escalation of the U.S.-China trade war and despite an agreement being struck with the UK that's since provided for an orderly EU exit into a transition period.
But the rub for Europe's single currency is that this weakness came before China's coronavirus has had chance to show up in any of the economic figures. And given that Europe's economy was wounded more in the trade war than the U.S. and China, it's now expected to be hit hard in the fallout from the virus.
"Business shutdowns in China designed to slow the spread of the epidemic are threatening economic activity in the euro-zone, particularly export-orientated countries like Germany," Barochez says. "What’s more, any remaining hopes that the European Union would make significant progress in strengthening the euro-zone have been dealt a significant blow. On Monday, Annegret Kramp-Karrenbauer resigned from her position of leader of Germany’s Christian Democratic Union (CDU), Chancellor Merkel’s party."
The Chinese economy now faces a sharp contraction in at least the first quarter which could meaningfully reduce 2020 GDP growth even if the coronavirus infection is brought under control within the period.
Coronavirus has turned major cities of many millions of people into ghost towns since early January and although authorities have made repeated attempts to restore production in key industries in some parts of the country, it's not yet clear that they've been succesful and the infection remains far from under control.
China is a significant trading partner for all economies but it's especially important to the Eurozone and for the global car industry. This in part because Chinese demand represents around 30% of the global market while the big four Eurozone countries have a similarly sized share of supply.
"EUR/USD has lost ground in seven of the last eight sessions as the already grim economic outlook was hit by a round of unsupportive data and mounting speculation around the negative impact of the coronavirus-related disruptions to supply chains and demand. On top of that, the funding characteristic of the euro prevent it to fully cash in on any recovery in risk sentiment (as we saw this week) and the dollar is showing more and more resilience," says ING's Turner. "In light of this, it won’t be easy for EUR/USD to invert the bear trend for now, and this week may actually make things worse."
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