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The Pound-to-Euro Exchange Rate is Threatening an Upside Breakout says RBC Capital Markets

- Pound-to-Euro could break higher as "bad news now priced in"

- Falling channel of Pound-to-Euro rate vulnerable to upside erosion.

- Yet more "no-deal Brexit" rhetoric remains a potential spoiler.

© IRStone, Adobe Stock

The Pound-to-Euro rate is currently the most interesting Sterling pair from a short-term trading perspective, according to Elsa Lignos, a managing director of FX strategy at RBC Capital Markets.

The pair is descending in a trend-channel on the charts but this may be vulnerable to an upside erosion because a lot of bad news is already "priced in".

"EUR/GBP looks really interesting, it's been in this rising uptrend, but it's actually one of our trades to watch. We're getting to a stage where there's actually quite a lot of short term bad news priced in, a lot of pessimism around the potential outcome of the negotiations and there could be some downside there if we see a break of this rising uptrend," says Lignos, in an interview with Bloomberg TV.

Lignos refers to EUR/GBP, which is the inverse of the Pound-to-Euro rate. She's not the only one who sees the Pound already carrying a lot of baggage as strategists at ING Group also warned Thursday against chasing it much lower. 

"We are uncomfortable over chasing GBP much lower now – especially in the absence of any tangible signs that we’re heading towards a no-deal Brexit," says Viraj Patel, a currency strategist at ING Group. "The prospect of a last-minute deal (as history has proven) on the Irish backstop means that risk-reward no longer favours pricing in no-deal Brexit risks – with scope for a sharp GBP rebound in this scenario outweighing any momentum driven moves lower."

The Pound fell by 0.6% against the Euro and a much larger 2.8% against the US Dollar this last week as traders dumped the currency in response to a surge in market unease over the geopolitical and global economic environment.

Comments from UK government officials acknowledging the mounting prospect of a "no deal Brexit" have also weighed on Sterling during August, although the last week has seen the Pound-to-Euro rate recoil higher by more than 100 points, from 1.1070 to 1.1180 on Friday. It has been as high as 1.1239.

For now, the exchange rate remains stuck in its descending channel and there is some scope for it to continue lower still. Recent news that ratings agency Fitch might downgrade the UK's credit rating because of the increased risk of a "cliff-edge Brexit" occurring in March has weighed on Sterling, driving EUR/GBP higher and the Pound-to-Euro rate lower.

Nevertheless, in favour of Lignos and Patel's more constructive GBP outlook, the steepness of the rise from last week's lows also indicates there is some scope for the Pound to go on eroding this downward sloping channel. 

A move above the 1.1239 level would provide an initial indication of a continuation higher. This could be expected to open the door for the exchange rate to target 1.1350, which is a level not seen since early July. A more aggressive push to the upside might even see it reach 1.1415 based on the width of the channel extrapolated higher.

The same analysis holds true for the pair's inverse GBP/EUR, and suggests a breakout confirmation point of 1.1238 and a conservative upside target at 1.1281 which is both the 0.618 ratio - or 'golden ratio' - of the height of the channel extrapolated higher and the location of the 50-day MA.

Longer-term forecasts for the Pound are currently near-impossible, according to Lignos, who says uncertainty about the exact timing of the UK's departure from the EU as something that makes forecasting a challenge. The UK's official exit date is March 29, 2019 although uncertainty about whether there will be a stand-still "transition period" after this point is a crucial issue for would-be forecasters.

"It's really difficult having a long-term call on Sterling at the moment and it's very difficult for investors positioning. If you look at bookies' markets at the moment it's actually very interesting that the expectation for when Brexit is actually going to happen is not necessarily March 2019, there is actually a lot of people betting that it's delayed by a few months or by a year, or even some people thinking it doesn't happen at all. So there's clearly a lot of uncertainty both around outcome and also around timing," Lignos says. "I think it's easier to focus on the short term really if you're trying to trade it."

The Pound-to-Euro rate was quoted 0.10% lower at 1.1174 during early trading Friday and is down by 0.07% for the 2018 year-to-date.

 

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