Marius Paun | London, UK | Senior dealer | Wednesday, 29th January 2020
It is the final week of Britain’s membership of the European Union so we thought it would be appropriate to take a look at the euro versus the pound.
Officially the UK is set to leave the EU on 31st of January 2020 with a withdrawal deal. After that, it will be a transition period scheduled to 31st of December 2020 during which the intention is for both sides to strike a trade agreement. It’s important to note that during the transition period, Britain will de facto remain in the EU’s customs union and in the single market. The British government has ruled out any extension to the transition period. Effectively if no trade deal is agreed and ratified by the end of the current year, then the prospect of a no-deal exit will be back on the table (the prospect of which was speculated and denied in the run-up to elections in the last months of 2019).
Ever since the 2016 referendum on whether to remain in the EU or not, the British population has been polarized, like rarely seen in the country’s modern history. Furthermore, investors sentiment towards the British pound has been closely linked to the political bias regarding the whole process. If one investor agrees with the UK leaving the EU then he/she probably would be bullish on the fate of sterling going forward. Conversely if one would think that Britain leaving will be an economic catastrophe, then one would make the case that pound is going to collapse.
The financial crisis of 12 years ago has undoubtedly dented the faith in fiat currencies in general. Separately, both sterling and the euro suffered from central banks manipulation, be it in the form of quantitative easing or zero interest rate policies. But consider them on a relative basis and political stability becomes an important factor. For example, the political instability that happened in the UK post-referendum has been considered the main driver pushing the pound down. It actually fell by 10% against the dollar on the morning after the exit vote and more than 7% against the euro. The ongoing decline that followed, coupled with the heightened volatility, were blamed on political and economic uncertainty. Investments in the UK also came under serious questioning.
Things changed once the Conservative Party secured the largest majority in the House of Commons in 30 years at the 2019 December general election. That gave them the green light to proceed with the Withdrawal Agreement Bill. In turn, the pound rallied against the euro to over 1.20 as forex traders appreciated a bit more clarity on the UK’s future.
Nevertheless, the transition period threatens to throw a spanner in the works. Prime Minister Boris Johnson is due to meet Ursula von der Leyen, the new European Commission president this week to talk about the exit Bill. Media reports that he will not agree to any extension beyond the end of 2020 despite EU officials agreeing that ‘to sign a trade deal with the UK in less than 12 months will be extremely challenging’. On top of that, all the feel-good factor that pushed sterling higher post-elections might slowly dissipate due to monetary policies. High levels of debt are a reality in the UK and Boris Johnson could pursue a policy to weaken the pound and boost exports (remember the currency wars a few years back?). Bank of England officials already hinted at lowering rates last week which could hurt the pound. The fear is that Britain’s exit may only offer short term support to its currency.
On the other hand, Germany’s IFO Business Climate figures were worse than expected on Monday. Consumer spending remains key to eurozone’s growth so the outlook is challenging for the euro as well.
The chart for EUR against the GBP shows a downtrend that started well before December election. If anything, the pound sterling reached its recent high against the euro (EURGBP at 0.8276) on December 13 and since then it rebounded slightly and went largely sideways. That consolidation pattern of the last 7 weeks also distorted the signal given by moving averages (it needs trending markets to be reliable).
On the downside, the bears will be looking to cross below the next support at 0.8416, followed by 0.8380. Ultimately, only a breach under 0.8276 will mean the long-term downtrend has resumed.
On the upside, there is resistance just above 0.85 mark and next at 0.8553. However, the buyers will target 0.8595 the high of January 14 as a break above that level will shift the short to medium term to bullish.