Euro to Pound Looks to Third Monthly Gain, But Long Trade Becoming Riskier

The euro to pound conversion is looking to make February the third month in a row in which it has ended higher against the British pound and we could well see the best exchange rate since 2014 being recorded over coming weeks.

The pound remained under selling pressure over the course of the past 24 hours amid general ‘risk-off’ sentiment in global market.

GBP/USD fell to a 4-day low of just above 1.4350, while the EUR/GBP surged to its best exchange rate in nearly a year just below 0.78.

As the below monthly chart shows momentum resides in the single currency's camp:

There are two parts to the EUR/GBP equation, and both are advocating for further gains. The global equity market sell-off  is decidedly pro-EUR, the reasons for which are described below here.

The other reason lies with genuine negativity to sterling. An expected widening divergence in interest rate policy between the European Central Bank's (ECB) and the BoE was one reason given by sterling-bulls for expecting the pound to reverse its down-trend versus the euro.

However, despite Mario Draghi announcing a review of policy in March and a probable increase in accommodation, the Bank of England came up trumps in the negativity department having struck an unexpectedly dovish tone when delivering their all-important Inflation Report. 

The UK is simply not seeing enough inflationary pressure to warrant interest rate rises - thus instead of divergence taking place between the BoE and the ECB, we have actually seen convergence.

Latest Pound/Euro Exchange Rates

	Live: 1.1451▲ + 0.07% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1062 - 1.1107
**Independent Specialist	1.1291 - 1.1336 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Some analysts had also expected Cameron’s recent draft compromise deal with EU’s Tusk on UK membership as providing extra support for the ‘stay’ vote, and therefore for sterling, however, despite concessions from the EU and the outline of a better deal for the U.K, recent polls suggest the public reaction has been negative - the opposite of what was expected - leading to even more weakening for sterling.

The Prime Minister is now in the unenvious position of having to decide whether to 'kick the can' and delay the referendum until 2017 in the hope that a more benign political climate emerges – or can be engineered – an option which risks harming the economy (and sterling); or go with a probable June 23 date and risk losing, and being ejected from Europe; an outcome which would probably be even more bearish for sterling.

With major themes currently working against the pound, it best hopes for regaining ground versus the euro (and other majors) is probably from strong data releases.

The euro meanwhile is being helped higher by global risk aversion. The euro is cheap to borrow and has therefore been used to fund global investments over recent years. Now that investors are turning shy they are buying back euros to settle their borrowing obligations.

The euro is no safe-haven, but it is benefiting from bouts of risk aversion.

The region's positive Current Account surplus is also a source of strength, especially versus the pound, whose Achilles heel is its negative Trade Balance, and therefore comparatively weak Current Account. 

Whilst global risk factors may be in their mature phase and could abate, leading to a weakness in the euro, this has not yet happened and oil seems to be consolidating after failing to break any higher. 

Gains Could However be Limited

From a purely technical viewpoint, the EUR/GBP pair has potential for more upside, although the amount of ‘safe’ upside is now potentially limited.

The weekly chart shows the remarkable inverted head and shoulders reversal pattern at the lows and the recent rally from the right shoulder, which broke above the patterns neckline and started to move higher.

This rally has now moved up to close to the 61.8% extension of the height of the pattern, at 0.7828, which is the minimum target.

Whilst it may go higher and reach the 100% extrapolation level at 0.8035, the long trade becomes slightly riskier the higher the rate goes above the 61.8% minimum expectation.

Looking at the daily chart and there are several noteworthy technical features which support a continuation of the current short-term up-trend.

Firstly, there is an enhanced golden cross which is a cross of the 200-day MA by the 50-day MA when both are rising.

It is enhanced by the fact that the cross-over is flatter than average lending to a probability of an extensive rally following on from the cross.

Secondly price action has actually formed a three-bar continuation pattern today, which consists of a long white up-day followed by a small body and then another long white up-day (circled in the chart below).

ADX, which is a measure of how trending the market is, is at 31, which is between 30 - 40 and therefore an optimum level for a three-bar continuation successfully extending higher.

If there is a break above Monday’s highs at 0.7767, then it should move up to a target at 0.7860 – however, for those wishing to play it safe the 61.8% extension at 0.7828 is another more achievable exit level.