EUR GBP could drop as GBP attempts to regain poise

Yesterday we wrote a piece on the GBP/USD in which we highlighted the possibility of a sterling recovery due to rising levels of inflation in the UK, which we believe will prevent the Bank of England from further loosening monetary policy. This morning, the pound initially fell further against the dollar and euro, but it has since bounced back to trade almost flat against both. It is far too early to call it a recovery, but the potential is there nonetheless.

Now against the euro, the pound may be able to make a more significant recovery than against the dollar because of the fact the ECB is a significantly more dovish central bank than the Fed. I believe the EUR/GBP has already topped out when it failed to hold its own above the 0.90 handle post the Brexit vote. Therefore the recovery we have seen of late represents, in my view, a normal retracement in what I think is going to be a downward-trending market.

The EUR/GBP could stage a much deeper retracement before it potentially falters, but it has respected the 0.8760/5 resistance level today which is interesting to note because the GBP/USD has in the meantime arrived at its own support area around 1.2100, as we highlighted yesterday. In fact, the EUR/GBP is currently displaying a reversal-looking candlestick formation on its daily chart off of this level: an inverted hammer/long-legged doji. This pattern will be confirmed if remains around the current levels by the close of play. The cross would look more bearish if it finds itself back below the broken resistances at 0.8705 or ideally 0.8670 now. If that happens then this could lead to further follow-up technical selling pressure in the days and weeks to come, initially towards 0.8500 but potentially beyond over time.

In the short-term, my bearish outlook would become invalidated if the EUR/GBP rises above 0.8760/5 resistance level. In this potential scenario, the next bullish objective or line of defence for the bears is at 0.8860, previously support.