The euro has seen its recent declines against the pound sterling cease confirming our stance that the single currency remains in a commanding position against its cross-channel peer.
The euro exchange rate complex is finding its feet after what has been a poor week thus far.
The decline against the US dollar has stalled and we believe strength in the EUR/USD will have a knock-on influence on the EUR/GBP rate.
Today the exchange rate is at 0.7951, still well below the 0.8075 level seen at the start of the week but higher than the mid-week lows registered at 0.7925.
The recovery will have come as no surprise to those who watched the pair approach the 20-day moving average and an historic support line.
Both were expected to acts as support levels preventing further declines; indeed this appears to have been the case.
However, looking ahead, much depends on time-scale and perspective:
For example, in the immediate short-term, the pair could easily fall another 50 points to the 0.7880s where a major trend-line for the whole 2016 rise is situated and likely to result in a bounce or even renewal of the up-trend.
Some analysts, such as Robin Wilkins from Lloyds Commercial Banking, see the pair falling even more deeply to 0.75:
“Medium-term the trend from the 0.6935 lows set in July 2015 remains intact, but we are now reaching a significant area of monthly resistance up to 0.8200 and would be the ideal area for a top and decline back into a broader medium-term range around 0.7500.”
Such a deep sell-off would halve the gains made since the 2015 November lows, however the sell-off so far has been too modest to suggest such a strong bearish retrenchment.
In the slightly longer-term, however, EUR/GBP is still likely to recover and rise again continuing its medium-term up-trend higher, which started at the November 0.6980 lows.
The current four-day sell-off is still not deep enough to indicate a reversal of trend, and although the MACD indicator has given a mild sell-signal that alone is not enough to suggest a reversal of the trend either.
Only a break clearly below the 50-day MA at 0.7840 would be enough to potentially question the authority of the up-trend, thus the euro is still likely to rebound versus the pound.
Indeed, this fits the view of several major analysts and economists, who see more downside for the pound in the run-up to the EU referendum in June.
Commerzbank See Euro's Uptrend Against Pound Sterling Failing
Not everyone is as enthusiastic about the euro's prospects going forward.
There is some hope for the pound to advance further as its recent strength confirms the EUR/GBP is likely to struggle to push it above the February/March high-water mark.
"We view the market as recently topped following a 13 count on the daily chart, complex divergence of the daily RSI and the failure ahead of 2008-2016 resistance line, which is located at .8162 – we look for failure," says analyst Karen Jones at Commerzbank.
Fundamentals remain Bearish for the Pound in run-up to Referendum
From a fundamental perspective we note there is little support for the pound which could even be completely “overwhelmed” before the referendum, according to analysts at J P Morgan, who see a potential £400-500 billion market for hedging against referendum risks.
A hedge is used by foreign investors who own sterling denominated assets, such as shares or property, for example, and enables them to protect the value of their investment in the event that the pound loses value.
It involves selling an equal amount of pounds as the investment and buying a currency such as the Swiss franc which is likely to gain in value if the pound weakens.
Given the fairly close contest between the stay and leave camp in polls, the level of hedging is expected to continue rising significantly in the eyes of JP Morgan who note:
“We remain squarely focused on the likelihood of continued GBP depreciation ahead of the EU referendum on June 23 as non-residents hedge UK exposure against the uncertain consequences of Brexit.”
Over half of foreign liabilities are owned by investors in the Euro-zone, so the main currency pair affected by hedging flows is likely to be EUR/GBP:
“Roughly one-half of these assets are held by European investors, as a result of which we expect a substantial amount of GBP hedging flow to be channelled through EUR/GBP and not just cable.”
“Key for GBP will be whether the official campaign makes any inroads into the still relatively large group of Undecideds who currently average 20%. Bookmaker odds for Brexit are also relatively steady between 30-35%.”
Their base case scenario, however, is that the UK will vote to remain in the EU, an outcome to which they assign a 60% probability, and that sterling will recover following the win for Bremain, rising to 1.50 versus the US dollar and 0.76-76 against the euro.