EUR/GBP Channel Holds As Yield Expectations Fluctuate

The Euro pushed higher against the Pound on the day as the outlook for an ECB rate hike improved on the back of better than expected fundamental data and strong demand for Spanish and Irish sovereign debt. Successful bond auctions from two of the most beleaguered countries helped ease concerns that the debt crisis could re-emerge amplifying the positive sentiment and export data that crossed the wires. A jump in current German business confidence was supported by a 5.2% improvement in exports leading to a rise in overnight index swaps. The instrument is now pricing in 28.1 bps in tightening over the next year up from 23.7 bps. The small increase isn’t that significant but stands out when compared to the decline in U.K. yield expectations from 38.2 to 15.6 in the past week. The sterling had been the beneficiary of a brighter interest rate picture as inflation above the central bank’s 3.0% threshold improved the case for a rate hike. The MPC left rates unchanged but the upcoming minutes from their policy meeting could point toward future tightening and inspire a EUR/GBP reversal, keeping the current channel intact.

Levels to Watch:

-Range Top: 0.8310 (Trend, SMA)

-Range Bottom: 0.8130 (Trend, Pivot)

Charts created using Strategy Trader– Prepared by John Rivera

Suggested Strategy

• Short: Place an entry at 0.8320-20-Day SMA
• Stop: Set the stop to 0.8420-100 pips in risk
• Target: The first target is 0.8130-lower bound

Trading Tip – The converging 20 and 50-Day SMA’s near the upper bound of the current channel adds to the case that we could see the resistance level hold. A break above the technical levels could spark a bullish rally and for those that are more risk averse, a tighter stop may be in order. The U.K. economy is expected to be on a stronger path of growth which could make it difficult for the central bank to refrain from tightening with inflation at such dangerous levels. A full economic calendar may provide the bullish catalyst that is needed to make our set-up profitable, but also holds the potential to continue the recent slide in yield expectations.

Event Risk for Europe and U.K.

Europe – Euro-zone construction and German producer prices are second tier releases that will most likely be overlooked by market participants. The main upcoming event risk for the Euro will be the PMI composite readings which will provide insights into the pace of growth in the manufacturing and service sectors. Signs of a slowdown in activity will depress yield expectations and could sink the Euro. Consumer sentiment crossing the wires at the same time could be overlooked but will have implications for domestic growth.

U.K. – The minutes from the BoE’s last policy meeting could dictate short-term direction for the pound, if they reveal a decided hawkish tone. If others take up the cause for a rate hike with Andrew Sentence, then markets will look to start pricing tightening by the end of the year. Conversely, the same rhetoric from the MOC that inflation will fall in line with target levels, could add to Cable’s current decline. The budget deficit for July will also cross the wires and signs that public borrowing is declining could also be a catalyst for bullish pound sentiment, but mounting debt will raise concerns that austerity measure may not be enough to reduce the increasing taxpayer bill and also serve to stifle growth. The pace of consumer consumption is expected to have slowed in July with retail sales growing 0.3% versus 0.7 the month prior. However, sustained domestic demand could be viewed as a positive and a sign that the recovery is on track.