While the EURUSD pair is mired in a tight range without the conviction to move it either way, GBPUSD is rallying strongly on the back of improving UK fundamentals and looks poised to test the June highs.
Since the beginning of August, the EURUSD currency pair has fluctuated within a 200-pip range between 1.32 and 1.34, and while we have seen both sides of the range tested in the past week, we have yet to see a breakout.
Aside from the summer doldrums, uncertainty about the outlook for the Eurozone and US economies has capped the moves in the currency. The first-half recovery in the US is now beginning to slow, while the first-half slowdown in the Eurozone is beginning to ease. However, there is very little confidence as to whether these trends can continue, which explains why the currency pair is trapped in its range.
Better-than-expected Eurozone trade and current account numbers failed to lift the euro (EUR) because the improvement was widely expected after similar increases in both Germany and France. Consumer price growth, on the other hand, dropped 0.5%.
The outlook for euro now hinges on this week's PMI numbers, which will give a fresh perspective on the Eurozone economy. Manufacturing and service sector activity is expected to grow at a stronger pace in the month of August.
It is also worth mentioning that yield spreads in Europe are compressing, with Spanish/German spreads falling to the lowest level since 2011. This is a sign that investors have grown more confident about economic conditions in the Eurozone periphery.
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It was a breakout week for the British pound (GBP), but contrary to our expectations, the UK retail sales report, and not the Bank of England (BoE) meeting minutes, acted as the catalyst that drove GBPUSD sharply higher.
Every little piece of event risk last week played its part in supporting the currency pair's move. The decline in jobless claims was nearly double the market expectations, while retail sales jumped 1.1%, and the decision on the new unemployment threshold was not unanimous, as Martin Weale voted against the move. This left the central bank with a slightly less-dovish bias and economic data supporting a stronger recovery.
The BoE has a relatively pessimistic forecast as to when 7% unemployment rate will be achieved, but if economic data continues to surprise to the upside, this target may be reached sooner rather than later.
The rally in GBPUSD suggests that investors are positioning for a stronger recovery, and with fundamental data supporting the move, we believe there's a reasonable chance that the June high of 1.5750 will be reached.
In the coming week, we don't have much in the way of market-moving UK data that could threaten the GBPUSD rally. Revisions to Q2 GDP numbers are on the economic calendar along with public sector finances, but no major surprises are expected from either report.
By Kathy Lien of BK Asset Management
