EUR/GBP Breaks Higher on Rumored Tapering

After reaching the highest levels since 2011, EUR/GBP looks set to continue climbing after a set of important emerging fundamental factors have sent the pair rallying to the upside. Besides the growing anxiety about a UK “hard exit” from the European Union which would largely reduce its ability to conduct business in mainland Europe without restriction, the ECB is also running into headwinds which will drive momentum in the Euro. The result is the perfect storm of factors that could conceivably send EUR/GBP back towards levels last seen in 2009-2010 as the pair breaks the longstanding post-crisis downward trend line and continues to accelerate higher. Unless “Brexit” negotiations experience better than expected results and the ECB decides to maintain its current policy strategy, there are few factors that derail further appreciation in EUR/GBP.

The Supportive Backdrop

Two important factors emerged over the last couple of sessions that have been the primary drivers of momentum for both the Euro and the Pound. In Europe, a report from Bloomberg discussing the possibility of the ECB tapering its ongoing asset purchases was enough to spur a near 100 pip gain in EURGBP over the course of Tuesday’s session. According to the news, policymakers are debating a reduction in the EUR 80 billion in monthly purchases currently being conducted. Even though easing could still be extended past the March 2017 program deadline, a consensus has been building amongst policymakers that purchases should be gradually reduced. This likely reflects a scarcity of assets available for purchase, with this development spurring speculation that the ECB is running out of ammunition. Should that be the case, the Euro will likely continue to rise as the Central Bank injects less money into the economy.

The UK outlook has been the other factor behind EUR/GBP momentum, with growing anxiety about what the “Hard Brexit” may look like for the economy. The difference between and a “hard” and “soft” exit is significant, with a hard exit leading to a complete loss of access to the single European market and the customs union that allows fairly free flow of goods and services across European borders. By comparison, a soft exit means that the UK would maintain access to the single European market and firms would keep “passporting” rights which enables them to engage in trade without additional taxes.While some research has pointed to a potential GBP 38 billion cost of a hard exit just for the financial sector alone, the overall implications of such a move are still difficult to estimate, adding to the pressure on the Pound.

Technically Speaking

On a longer-term basis, the EUR/GBP pair has been mired in a downward trend since the 2009 during the heights of the financial crisis.The sovereign debt crisis and gradual accommodation that was implemented by the ECB as a result sustained the downward pressure on the EUR/GBP pair for a number of years. However, since the Brexit vote back in June, the situation has rapidly reversed as evidenced by the price action.In keeping with traditional technical analysis rules, the correction happens faster than the move, evidenced in large part by the rapid upswing in EUR/GBP that began at the end of 2015. Since then, the prevailing downward trend line that kept a lid on upward momentum was broken back in June with a candlestick close above the line. Since touching the highest levels since 2011, the next major long-term resistance level lies at 0.8845 before 0.9030.

On a more immediate basis, the tremendous gains in the pair are running up against resistance, indicating a potential correction may be in the pipeline as EUR/GBP retreats from recent exuberance. Although the momentum higher may persist over the medium-term, near-term a pullback is in order. Besides reaching the top of an emerging equidistant channel formation, the Relative Strength Index suggests that the pair is overbought and slightly overvalued, potentially preceding a downward correction to the most recent upward trend. A pullback towards the 50-day moving average which is currently trending below the price action places support at 0.8600 on the downside. If this threshold is crossed, the next major level is the lower channel line above 0.8400. Any dip below this level could signify a downward breakout whereas a bounce could indicate a great entry point for investors looking to capitalize on bullish momentum.

Looking Ahead

The EUR/GBP will continue to be sensitive to developments surrounding the ECB’s monetary policy measures and the UK’s ongoing work to fulfilling the Brexit obligations. While neither is likely to be resolved over the short-term, adding to the upside potential in the pair, the bullish case is not without risks. For one, if the ECB decides against tapering asset purchases, it could reverse the Euro’s most recent gains. On the other hand, if the UK opts to negotiate for a “soft exit”, it could spur renewed confidence in the Pound, helping to offset the fresh round of losses experienced. However, absent these two developments, EURGBP momentum higher is likely to persist over the medium-term, bolstered in large part by technical factors.