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Outlook for Pound to Euro Exchange still Positive Despite EUR's Italian Referendum Short-Squeeze

pound exchange rate 2

Pound to Euro Rate Today: 1.1869, week's best: 1.2042, week's low: 1.1793
Euro to Pound Sterling Rate Today: 0.8425, week's best: 0.8480, week's low: 0.8304

The Euro has been the strongest performer over the past 24 hours but the gains are unlikely to halt the British Pound's recovery rally.

The Euro was the best-performing G10 on the day it was announced Italians were not going to accept the proposals forwarded by their Prime Minister Matteo Renzi to change the country's constitution.

The initial knee-jerk reaction to news that No had carried the day was to sell Euros, which allowed GBP/EUR to breack 1.20 for the first time since July 22.

However, the losses were quickly pared and reversed as markets show an incredible ability to shrug off the entire event:

Euro is today's best performing currency

"The swift recovery of the markets despite the ramifications that the referendum may have for the Eurozone is notable – in a year of financial shocks such as Brexit and the Trump election victories, it is entirely possible markets are becoming more resilient," says Paresh Davdra at RationalFX.

"Markets outside Italy were apparently largely prepared for a ‘No outcome’ and didn’t see any big global consequences outside Italy. The market was even ripe for some kind of short-squeeze as the event risk was out of the way," says Austin Hughes at KBC Markets in Dublin.

It is this short-squeeze of negative bets against the Euro, built in the run-up to the referendum, that saw the Euro push sharply higher.

In a few waves the euro was squeezed higher. The pair already set a ST correction top north of 1.07 around noon," says Hughes. "The reaction of sterling, especially of EUR/GBP, was as remarkable in EUR/USD."

Hughes notes EUR/GBP temporary filled bids below the 0.8333 support area early in Asia. "However, from the start of European trading, EUR/GBP joined the short squeeze of EUR/USD."

Latest Pound/Euro Exchange Rates

United-Kingdom European-sUnion
Live:

1.1954▲ + 0.03%

12 Month Best:

1.1988

*Your Bank's Retail Rate

 

1.1547 - 1.1595

**Independent Specialist

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Renzi to Stay, Financial Crisis Fears Overblown

In latest developments, Renzi has delayed his resignation to oversee the passing of the country's budget, something that will further soothe markets are acutely focussed on the outlook for Italian banks, many which will need funding over coming weeks.

How does the political vacuum opened by Renzi impact on the functioning of Italian money markets?

"The immediate market focus will be on the struggling banking sector. Not least because the new resolution regime makes government support much harder, Italy has been desperate to find capital via the private sector. The fate of the ongoing capital raising of Monde dei Paschi di Siena is first on the line, and its success or failure will have material consequences for the other banks," says Holger Sandte at Nordea Markets.

Sandte believes the need for further government support, in one form or another, has increased with the clear no vote. Still, the outlook for the state being able to contribute to solving the problems of the Italian banks for good would require a strong government – something that looks unlikely for now.

Lorenzo Codogno, a former chief economist at the Italian Treasury tells Wake up to Money that he doesn't expect an early election, or a referendum on the Euro.

But, the country's political gridlock will continue until at least 2018, as a new caretaker government struggles to keep the peace.

President Mattarella will most likely launch new government formation talks within the current parliament.

"On the government bond markets, there were rumours that the ECB was willing to use the flexibility offered by its QE programme to prevent a sharper rise in Italian bond yields. A failure to do so could become self-fulfilling in the short-term, as it would dent confidence in the central bank’s ability to control the bond markets," says Sandte.

The prospect of a financial crisis on the back of the No vote and Renzi's resignation are however considered small by Sandte:

"It is true that markets have largely shrugged off seemingly ex-ante market-unfriendly outcomes quickly several times in the past (e.g Brexit and the US presidential election). It would thus be premature to call for another crisis in financial markets, especially as the no vote was expected, even if the margin was surprisingly large."

GBP/EUR Chart Outlook: Looking for a Break of 1.20

With regards to the outlook, the question is whether the Renzi bounce can extend from here.

There are signs that we are witnessing something that could be short-lived.

"Europe’s bounce today definitely has the ‘relief rally’ feeling to it, so in the face of a rising euro and pre-ECB nerves it will be interesting to see whether gains can be sustained in coming sessions. No-one really expected Brexit or Trump, but here the result was priced in, and as a result we may well have to endure some extended weakness now that the initial excitement is out of the way," says Chris Beauchamp, Chief Market Analyst at IG in London.

From a technical perspective, Sterling appears aligned to offer further appreciation in the coming week after last week's comments from the Brexit Minister David Davis opened a chink of hope that the UK might be able to buy membership of the single market.

This would protect exporters and the City from a ‘Hard-Brexit’ which it was feared would lead to a loss of trading rights with the EU.

The Pound is likely to continue being sensitive to ‘Soft Brexit’ commentary this week and may rise higher if more information on the government’s negotiating stance emerges.

The Euro may meanwhile strengthen if Mario Draghi strikes a more confident tone at the European Central Bank (ECB) rate meeting on Thursday and hints that the Bank's quanitative easing programme is to end during 2017.

Although the ECB is forecast to extend its QE programme by six months, there has been talk recently that it may talk about tapering the number of purchases instead – which would be Euro-positive.

The GBP/EUR pair is in a strong, short-term, uptrend and has made highs of 1.1951 in the past week.

The uptrend looks a little overbought and the MACD momentum indicator looks like it is about to cross under its signal line – which would be a bearish sign.

GBPEURDec03

We remain, nevertheless, cautiously bullish, seeing a break above the 1.1951 highs as providing confirmation of more upside towards a target at 1.2000.

Resistance at that level, however, from the September highs, is likely to limit further gains.

The R1 monthly pivot at 1.2079 is also likely to prove an obstacle to further upside.

Monthly Pivots are sold levels of support or resistance where traders often open counter-trend orders.

Events to Watch for the Pound this Week

A major release for the pound will be Services PMI for November on Monday December 5 at 9.30 (GMT). The data beat expectations and analysts now forecast the UK economy to grow 0.5% in the fourth quarter - a distant cry to the recession that was forecast by big-name economists in the aftermath of the EU referendum.

On Wednesday, December 7 at 9.30, there is the release of October Manufacturing Production from the Office for National Statistics which should give an official steer as to how the sector is performing.

On Friday, December 9 at 9.30, the Trade Balance for October is Released and foreign exchange analysts will be interested to see whether the decline in the value of Sterling has helped closed the country's notable current account deficit.

 

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