Image © Adobe Images
The British pound looks due a breather against the euro this week, and soft UK data could deepen any pullback.
The Pound to Euro exchange rate hit a fresh multi-month high at 1.19 on Monday thanks largely to a weaker euro, but we expect the pair to settle slightly lower in the coming days as stretched conditions unwind.
Pound Sterling Live's medium-term view of sterling strength is intact, so any setback should be measured, and a heavy week of UK data will shape how far it runs.
From a technical perspective, the Relative Strength Index (RSI) - the bottom panel in the below chart - shows the pair has now spent about as long in overbought territory as it did in July, before that episode gave way to a pullback:
GBP/EUR daily chart. Image © Pound Sterling Live, chart created with TradingView.
GBP/EUR trades at 1.1866 at the start of the new week, having pared earlier gains as EUR/USD fell in early Asian trade and then recovered.
Monday's advance lifts the RSI to 78, well above the 70 threshold for overbought territory and close to the July extreme.
What does an overbought reading denote? It tells us the pair has risen faster than usual over a short period, leaving it vulnerable to profit-taking and consolidation. The reading does not mark a top on its own, and the persistence of these conditions has defied our expectations.
The RSI crossed above 70 at the start of October, and the July episode lasted around two weeks, so the current one has now run for a similar stretch and we think the time for a pullback and consolidation is nigh.
The pair also sits a full percent above its 21-day moving average - the blue line - a deviation that looks extended.
The 21-day is pointing sharply higher and is converging on graphical horizontal support at 1.1750, the red line, which makes that area a support band. Because the average is rising so quickly, a spell of sideways trade would close much of the gap without the pair having to fall far, which fits our expectation of a modest pullback.
EUR/USD looks supported above 1.1150, and only a breakdown there would likely open the door to a sustained move in GBP/EUR above 1.20.
We think the euro stabilises this week, prompting GBP/EUR to settle slightly lower as it unwinds from overbought, while our medium-term Pound to Euro forecast still looks for rates above 1.20 before year-end.
A week ago we looked for overbought conditions to give way to consolidation or a shallow pullback. The pair did consolidate between 1.1795 and 1.1867 through midweek, but Friday's advance and Monday's push to 1.19 show the overbought phase has lasted longer than we allowed for.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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Talk to a specialistFrench Unrest Weighs on the Euro
Monday's euro weakness follows a weekend of unrest in France that highlights the entrenched difficulties facing Europe's second-largest economy.
Student-led protests over school underfunding were joined by the Gilets Jaunes movement opposing austerity and rising living costs, and the Interior Ministry said nearly 2,400 people were arrested on Saturday alone.
President Emmanuel Macron expressed "anger and shame" at the violence in a televised address on Sunday, but stopped short of declaring a state of emergency.
"France appears to lack the political ability or will to make meaningful changes to reduce the deficit or introduce structural reforms that lift growth over the medium term," say economists at Nomura in their Europe Economic Weekly of 16 October.
A Heavy UK Calendar Tests Sterling's Advance
While the euro side of the cross is supportive, the pound has a big dose of domestic data to navigate this week, and the rule of thumb applies to each release: a print above consensus supports sterling, and a miss weighs on it.
Tuesday's labour market figures come first, with the market looking for unemployment to rise to 5.0% from 4.9% and pay growth excluding bonuses to quicken to 3.6%.
Wednesday's September inflation report is the week's calendar highlight for GBP/EUR, with consensus at 3.4% year-on-year, up from 3.1%, core inflation at 2.7% and services inflation at 3.5%.
Friday brings retail sales, expected to fall 0.1% month-on-month, and the flash PMI surveys, where the composite reading is seen at 51.7.
The bar for a positive surprise is high, because market pricing shows a better than 90% chance of a Bank of England rate hike on 5 November and four hikes over the coming year.
"Resilient UK growth has reinforced market expectations of a near-term rate rise, but limited domestic cost pressures still argue against the scale of tightening priced by markets," says Lloyds in its Market Insights Weekly of 16 October.
With that much tightening in the price, below-consensus prints could entice a correction lower in sterling, which would be consistent with the GBP/EUR unwinding from overbought this week.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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