EUR/GBP plagued by economic and political uncertainties
Fawad Razaqzada May 24, 2018 1:00 PM
Despite the overall weakness in UK data recently, the BoE is still more likely to hike rates before the ECB ends QE. This makes us fundamentally bearish on the EUR/GBP. Although Brexit-related and political uncertainties remain in the UK, this is offset by the fact that the Eurozone has its own problems to deal with – Italy, for example.
When you pair two weak currencies against each other, what do you get? Side-ways chop. That’s exactly what has happened to the EUR/GBP for the past several months as data from both the Eurozone and the UK have been far from impressive. So far in the first half of 2018, macroeconomic pointers from the Eurozone have been poor with German data being particularly disappointing. That trend continued this week as the latest PMI data from the Eurozone came in weaker than expected, showing a slowdown in growth of activity in both the manufacturing and services sectors. In the UK, consumer inflation weakened further from its December 2017 peak of 3.1%. It softened to a still-high rate of 2.4% in April from 2.5% the month before. The recent soft patch in UK data and weakening of inflationary pressures has discouraged the Bank of England from raising interest rates this month. But there was a glimmer of hope for the pound today as retail sales in April made back their entire losses from the month before as the improved weather boosted sales of fuel, food, clothes and household goods.
Despite the overall weakness in UK data recently, the BoE is still more likely to hike rates before the ECB ends QE. This makes us fundamentally bearish on the EUR/GBP. Although Brexit-related and political uncertainties remain in the UK, this is offset by the fact that the Eurozone has its own problems to deal with – Italy, for example. Political uncertainty is rife in Italy after the anti-establishment Five Star Movement and right-wing League were elected to form a coalition government, which opposes years of EU austerity and wants to renegotiate Italy's debt. This uncertainty has weighed heavily on Italian shares and bonds, and the euro. Among the other risks facing the Eurozone is protectionism, which was highlighted in the latest ECB meeting minutes. The ECB thinks protectionism risks are now more pronounced and this raises uncertainty over economic outlook, which requires caution.
On balance, due to the above fundamental reasons, the pound has a slight edge over the euro. Indeed, the EUR/GBP, which topped out around 0.9300 last August, has been putting in a series of lower lows and lower highs. As a result, a bearish trend line has been established, while the slope of the 50- and crucially 200-day moving averages have turned negative, thus objectively telling us that despite the choppiness the trend is indeed bearish for the Chunnel. Consequently we will be looking for lower price levels going forward, with the next key supports coming in at around the round handles of 0.8700, 0.8600 and 0.8500. We would maintain our slightly bearish bias on this market so long as it makes technical sense. In this case, a break above the trend line and most recent high of 0.8840 would probably invalidate the bearish view.