Pound Looks to Break 1.30 Against Euro this Week
The sudden move lower in the pound to euro exchange rate (GBP/EUR) in the wake of the ECB press conference was an overreaction in response to the ECB President's comments about future interest rate direction.
- The pair has has closed above 1.28 for the past 10 of 11 days now
- 1.2850 seen as the line-in-the-sand that will support sterling against weakness
- 1.30 is the magic line that must be broken and held if an uptrend is to establish
The euro exchange rate complex has given up much of the gains made during and after the ECB press conference.
Markets were proven to have been ‘trigger-happy’ in their desire to press the buy button on the euro having heard ECB President Mario Draghi seemingly dismiss the prospect of further interest rate rises.
Draghi's throw-away comment at the ECB press conference in which he suggested that negative rates have reached their downside limit, caused a massive short covering rally in the euro which spiked four big figures off its lows.
"The market however grossly overreacted as Mr. Draghi cleared meant that under current conditions no further move to negative rates would be necessary,” says Boris Schlossberg, Managing Director of FX Strategy at BK Asset Management.
The resultant weakness in the single currency has allowed the pound to climb back above the 1.2900 line.
The pair has has closed above 1.28 for the past 10 of 11 days now, but in this time it has also failed to close above 1.2960 confirming a tight range and that a struggle lies ahead with regards to advancing further.
{module Intext Live Currency Rates: GBP/EU
The ECB’s cut to interest rates means the euro is now even cheaper to borrow, in fact the Bank is effectively paying commercial banks to borrow money from them.
As we argue here, the desirability to borrow euros and invest them elsewhere has grown substantially. This will ensure euros are sold on FX markets to buy other currencies to fund these investments.
This is known as the ‘carry trade’ and after yesterday we would expect this dynamic to step up a gear.
It also means that when stock markets are rallying, the euro will likely suffer, so watch for this dynamic going forward.
“Our initial thoughts are that yesterday’s price action was a bit of an overreaction and we think that risk sentiment will fare well over the coming weeks once the dust settles,” says Viraj Patel at ING.
Outlook for the Euro
ING’s Patel says the portfolio rebalancing channel of the ECB’s QE policy should in theory be (a) positive for risk appetite/liquidity and (b) slightly negative for the EUR, but any downside is now likely to be more drawn out.
“We retain our view that the pair will drift back to 1.08 in 1M, though a greater onus will be on the USD side,” says Patel.
CitiFX reckon the euro is a sell on strength, echoing a strategy that has been popular for some time now.
“EUR and euro rates appear to have significantly overreacted to selective parts of the ECB
commentary,” say CitiFX in a client brief, “is no denying that the ECB has over-delivered on the stimulus front and the medium term outlook is now a firm ‘sell on rallies’ to levels approaching 1.1300.”
Lloyds Confirm Forecast to End the Year Above 1.35
In the wake of the ECB event Lloyds Bank have confirmed they are looking for sterling to advance further against the euro.
Analyst Gajan Mahadevan is by no means looking for an agressive rally, rather the sees consolidation as being the flavour for the rest of 2016.
This will disappoint those who were hoping for a sharp move higher in sterling-euro after the Eurozone referendum in June.
Mahadevan notes the Bank of England's reluctance to raise interest rates as a factor that will likely keep sterling demand limited, even in the event of an 'in' vote at the referendum.
"Given that the ECB appears to favour a weaker currency – to help drive inflation higher – it is likely to be frustrated (yet again) that its stimulus efforts have not had the desired impact on the currency," says Mahadevan.