After 6 Days of Gains Pound Stalls Against Euro on Shock UK Data, 1.28 Now Support

The British pound's relief rally against the euro appears to have ended on account of data that suggests the UK's economy is slowing down faster than previously thought.

The British pound has been in recovery mode against the euro for 6 days now having formed a base at just above lows recorded at 1.26 at the hight of the 'Brexit-mania' selloff.

The recovery appears to have ended thanks to a run of poor economic releases at the start of March.

The release of awful Services PMI data saw the pound to euro exchange rate fail to hit the target we had set for the short-term recovery set at 1.30.

Services PMI read at 52.7, well below the 55.2 expected meaning the dominant services sector is nearing contraction territory.

Anything below 50 signals decline.

In the wake of the data we have heard talk of the need for the Bank of England to consider cutting interest rates.

It can't be understated as to just how negative a rate cut would be to sterling; the currency has been held aloft for three years now by the promise of an interest rate rise being 'just around the corner.'

“The extent of the slowdown will be a shock to policymakers and surely puts to bed any talk of the Bank of England raising interest rates," says Chris Williamson at Markit, compilers of the PMI series, "the focus will instead increasingly shift to whether policymakers may soon need to dig deeper into their toolbox to introduce new measures to shore up the economy with additional stimulus, and what tools might be used.

Lloyds Bank agree:

"Today’s report points to an increasing likelihood that some on the MPC – most likely Andy Haldane and Jan Vlieghe – may soon be tempted to vote for a cut in Bank Rate."

Latest Pound/Euro Exchange Rates

	Live: 1.1452▲ + 0.08% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1063 - 1.1108
**Independent Specialist	1.1292 - 1.1337 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Short-Covering Rally, Technical in Nature, No Fundamental Underpinnings

The move higher by the pound is technical in nature and we warned last week that a heavily oversold market was ripe for a strong recovery.

When we say 'recovery' we refer to a short-term, yet impressive, bounce as opposed to a sustained turn in trend.

Full points go to strategists at DNB Markets who issued a pro-GBP trade idea in the midst of the hysterical Brexit sell-off having warned that the move lower was exaggerated.

Calling a turn in the downtrend would be far too premature at this stage but the call by DNB goes some way in illustrating that we can pick oversold markets.

Markets were so heavily pitted against the pound that there were fewer and fewer market participants left who could continue to drive the move.

What results is a crowded trade that is running out of momentum. When a slight recovery occurs large numbers are stopped out and forced to buy sterling and sell euros to close out their bets. This creates a snow-balling effect as more pounds are purchased in turn forcing others out of the trade the further the recovery goes.

Ultimately though the clear-out of crowded positions should see the move fade and allow the market to await fresh signals. 

1.28 to Act as Support

The move higher towards 1.28 is significant in that it has seen the GBP to EUR conversion break above its 20 day moving average.

This level will likely now form support and protect the British pound from excessive downside pressures.

We doubt much appetite will build for the euro ahead of the ECB meeting on the 10th of March which further advances the case for 1.28 as being a decent short-term minimum.

With regards to a broader recovery, we would want to see the GBP/EUR break above the 50 day moving average, around 1.37, before we had any confidence in calling an end to the worst of the selling pressure.

Nevertheless, it appears sterling is slowly trying to break above the upper limit of the descending channel it has been caught in since November:

What is important to note here is that the last time such a move was attempted, in early February, the move proved to be false.

The pound entered a decidedly bearish stretch as uncertainty mounts ahead of Britain’s EU vote on June 23 and the topic is providing a vacuum in which bets against sterling are able to flourish.

Window of Opportunity for those with Euro Payments

Recent strength offers those with outstanding euro payments a rare opportunity to cover themslves; as we note here our base case is for a continuation of the move lower to 1.25.

Indeed, strategists will be increasing their bets against the British pound the higher it goes

"Sterling tiptoed above seven-year lows though its rise and disappointing U.K. manufacturing data showing the slowest growth in about three years would leave the pound ripe for selling on any bounce," notes Joe Manimbo at Western Union.

If a Thursday report shows that Britain’s more influential services industry slowed more than expected, it could open the door to a U.K. rate cut in the months ahead.

Targetting 1.25 and then 1.2250 Longer-Term

Looking beyond the next few days we remain of the opinion that the direction that offers the least resistance for the GBP to EUR is downward.

We have been targetting 1.25 since the beginning of February and are confident that a move to these levels remains viable.

We are note the only ones expecting the downside pressures on the GBP to continue.

"Several obvious supports have given way over recent months (with prices unable to post a meaningful low in the meantime) and the broader technical environment here is now dominated by supply as a result. Some support should emerge on approach to 1.2500 but any rebounds from this psychological point will be viewed as corrective ," says Lucly Lillicrap, risk manager at AFEX.

Lillicrap says in her opinion 1.2250 or so now looks to be achievable going forward.

"Interim rally attempts face little meaningful resistance until 1.2800 again initially though only beyond the distant 1.3000 level as well is overtly positive," says Lillicrap.

The only thing that could invalidate the downtrend is significant action at the ECB at their 10th of March meeting.

Expectations for action are high, but judging by the strong recovery we are seeing in EUR/USD markets are not overly concerned.

We believe the higher the euro exchange rate advances over coming days the more damaging the shock of unforseen ECB action becomes.