EUR/GBP Channel Looks to Yield Expectations

The Euro and British Pound have benefitted from a return of risk appetite where both currencies have made gains against their safe haven counterparts. However, the single currency has outshined the sterling as it maintains a stronger relationship with risk and is also benefitting from rising yield expectations. Indeed, ECB member and head of Germany's Bundesbank Axel Weber in a CNBC interview stated that, Europe is on the brink of a self sustaining recovery. Confidence in growth and rising inflation will put the central bank on alert, which will shorten the horizon for an expected rate hike. An upward revision in U.K. GDP makes the case that the island nation is on the cusp of its own sustainable period of growth. Therefore, without the hurdles of indebted low growth nations, as the economic union posses, a brighter yield outlook could emerge providing sterling support-keeping the pair within its descending channel.

Levels to Watch:

-Range Top: 0.8235 (Trend, SMA)

-Range Bottom: 0.8050 (Trend, Pivot)

Charts created using Strategy Trader– Prepared by John Rivera

Suggested Strategy

• Short: Place an entry at 0.8240
• Stop: Set the stop to 0.8300-60 pips in risk
• Target: The first target is 0.8140- 8/23 low

Trading Tip – Inflation in the U.K. above the central bank’s 3.0% threshold compared with Europe’s price growth below target levels adds to our fundamental case for a EUR/GBP reversal. The BoE has the greatest cause to raise rates and that will keep the yield argument in its favor. The upper bound of the descending channel has withstood a prior test adding to its validity. However, the 0.8140 handle has been a source of support and could limit our profit potential on the trade. A break above our stop loss could signal a bullish breakout and trader may look to position themselves accordingly.

Event Risk for Europe and U.K.

Europe – An ECB rate decision highlights a week of major releases which also includes employment and inflation data. Early forecasts are for the number of unemployed in Germany to have declined for a thirteenth straight month. An imp[roving labor market will eventually give way to higher wages which is the greatest source of headline inflation and a major concern for the ECB. However, the E.Z. CPI-estimate is expected to have declined to 1.6% from 1.7% which could dim the outlook for yields and weigh on the single currency. Ultimately, the post release comments from the central bank will have the greatest impact on the outlook for future monetary policy and Euro direction.

U.K. – Housing and sentiment data will start the week of event risk and both second tier indicators could have short-term impacts on direction as they will provide insights into the potential for a suitable recovery. The PMI manufacturing reading will have a much greater impact on the outlook for future growth as the sector has been its main source, but forecasts are for a slight decline to 57.0 from 57.3. Mortgage approvals will also be pivotal as tight credit markets will force the BoE to remain on hold, especially considering the outlook is for a decline to 46.5K from 47.6K.