Forget the EU vote...GBP is set for sterling gains against the euro
- GBP is enjoying strong fundamentals post the general election
- The euro remains a fragile currency for any lingering euro bulls
- UK vote on EU membership is not a massive threat to the pound
By Mark Sturdy
The recent correction in GBPEUR, was driven by two factors: uncertainty during the UK general election; and the significant correction in the US dollar, driven by unexpectedly weak data that placed a question mark over the timing of the expected US rate hike.
In the event, the US Federal Reserve's chair Janet Yellen has cleared the uncertainty over US interest rates by declaring last week that US interest rates will start to gradually rise from this year, a comment that has helped the dollar rise and turned the spot light back onto the Eurozone, Greece and the euro.
Let's take a look at the weekly chart, where we can see the following:
- The market has broken three major levels of support.
- The prior Lows at 0.78 which now act as massive resistance to ally rally by the euro
- The rising diagonal (bull trendline support) from 2000
- The prior high support at 0.7255 from 2003. This is a major breakdown
GBPEUR weekly chart
From the daily chart we note:
- A short-term catalyst for the bears is a completed bear parallel flag
- The retracement to the lower diagonal of the flag (good short-term resistance) is, we believe, a selling opportunity.
Resounding election result removes GBP uncertainty
Turning to the UK, the election produced a surprise Conservative majority government which removed much, but not all, uncertainty afflicting the pound. Although the Conservatives are no longer in partnership with the Liberal Democrats and thus free to pursue the policies outlined in their election manifesto, the feeling is that the core of UK economic policy will not be too different in this Parliament from the last.
That means traders can now focus more on economic fundamentals and less on political risk.
Although UK Q1 GDP has cooled a little, there are signs of strength. Last week’s strong retail sales suggest that Q2 will see a stronger result. This, together with still-low inflation and historically low interest rates, is positive for the pound. Especially when compared to the still-weak economic performance of the Eurozone economy.
Add to that the continued uncertainty generated by Greece, and the euro remains a fragile currency for any lingering Euro bulls.
But all is not plain sailing for the pound. The UK government has promised an in/out referendum on the UK’s continued membership of the European Union. But while there is a strong chorus that constantly calls for a UK exit, it doesn't necessarily represent the majority of public opinion.
But I believe the prime minister, David Cameron, knows this. His decision to call a referendum is more likely a strategic play to silence those Eurosceptic voices both within and without the Conservative party. This is a smart move since the last Conservative administration under John Major was constantly dogged by in-fighting over Europe.
So how big an issue is the EU referendum for Sterling right now? I don’t think it’s that big at present. The prime minister has only just begun his attempt to renegotiate the UK’s relationship with the UK’s EU partners. He won’t set a time table for the referendum and the associated campaigns until he judges he has achieved all he can by renegotiation.
Moreover, we won’t really have a good idea about public opinion until the pollsters start publishing regular opinion polls.
Since the referendum is expected in late 2017, we don’t think the pound is currently trading on the probabilities of that event.
So for now, the main dynamics likely to drive GBPEUR over the medium term are the strength of UK growth compared to that in the Eurozone, the level of UK inflation and what that means for UK monetary policy and the health of UK public finances.
And these all currently favour a stronger Sterling performance against the euro.
– Edited by Oliver Morrison
Mark Sturdy is owner of Seven Days Ahead