GBP revival looks vulnerable as Brexit issues continue to cloud outlook
GBP rose above USD 1.3100 last week for the first time since early August and even clawed back some losses from the robust EUR – but it is hard to see GBP making significant further progress in the absence of more clarity over the UK’s future trading relationship with the EU.
Indeed, Brexit is the dark storm cloud that continually rains on GBP’s parade. It’s hardly surprising that many speculators plan to short-sell GBP all the way up to GBP/USD 1.3250. And much of GBP’s recent gains reflect weakness in USD driven by disappointment over US economic policy.
The recovery against the EUR looks particularly temporary unless the European Central Bank (ECB) makes a concerted effort to talk the single currency down, which it hasn’t done with any real zeal yet. To some extent ECB policy is dictated by the weakest large Eurozone member – in this case Italy. However, Italy is recovering – its GDP could grow 1.5% next year and it grew by that rate in Q2 this year and is better than its historical average since Eurozone membership. It is possible therefore that the ECB might tolerate a gradual EUR appreciation, but not a fast one.
A big factor is whether it will make a tapering announcement in October for its quantitative easing programme. A soaring EUR would likely dent its resolve.
However, there have been some straws for GBP bulls to clutch at. The UK government has hinted at some flexibility, such as trying to negotiate a transition period after the UK leaves the EU by April 2019 giving the economy more time to adapt. If that comes to pass the markets would see that as a positive for GBP – though the EU-27, the European Parliament and some regional parliaments would have to agree to that. The EU-Canada trade deal shows how challenging that could be.
Meanwhile, the UK economy remains sluggish with domestic consumption constrained by inflation and low wage rises while improved global economic growth seemingly passes it by. Weak GBP has not brought about an export surge, unlike when the UK left the European Exchange Rate Mechanism in the nineties. This is surprising given reports of rising manufacturing output, increasing manufacturer profitability with exporters reporting more foreign orders and UK firms with oversees operations, of which there are many, now having more valuable income in GBP terms.
Later in the year there could be some pick-up in UK GDP growth, but it is unlikely to be spectacular.
A big negative for GBP is politics. Any observer can hardly fail to notice that the UK’s political establishment is deeply fractured and far prefers fighting and negotiating against itself rather than ensuring the UK is best prepared to leave the EU. It will undoubtedly make Brexit more difficult and the lack of a credible and coherent post-Brexit economic plan is also a concern.
Given that investors don’t have a clear idea of UK direction after Brexit -- some will not invest and all this adds up to a drag on GBP and the economy. Also, traders should watch out for the Conservative party conference on Oct 1-4 where the Prime Minister could upset FX markets by sounding intransigent towards the EU in front of the largely Eurosceptic party faithful.
Overall the odds are still good that GBPEUR is heading towards parity.
TECHNICAL ANALYSIS - EUR/GBP pullback looks temporary
EUR/GBP has been on the rise since late November 2015 with numerous counter-rallies. There’s little reason to believe that the recent pull-back isn’t simply a repeat of the same pattern. The recent high of 0.9306 and the subsequent pull back was fairly calm suggesting that the long-term rally is still intact.
Indeed, the daily RSI has retreated from over-bought levels and is well into neutral territory and the pair are heading towards the lower Bollinger band and remain well above the 50-day simple moving average (turquoise blue) and the 200-day SMA (dark blue). Indeed, the rally could resume this week or next.
Resistance can be seen at 0.9266, 0.9306 and 0.9350 with support pegged at around 0.9095, 0.9050 and 0.8980.
By Justin Pugsley, Markets Analyst, MahiFX