Weakness in the pound in recent days has given EUR/GBP the opportunity to recover. After testing support at 0.8082, the lowest level since the end of 2012, this cross started to look oversold, and has been consolidating during recent sessions. However, we think that this is a temporary period of respite and the bearish trend will continue because:
- Key resistance at 0.8158 – the 61.8% Fib retracement of the July 2012 – March 2013 advance - could thwart the upside in the near term (see chart below).
- The daily MACD remains below its zero line, which suggests that the down trend that started in August 2013 remains in place.
- The ECB meets next week, which could focus minds on the limited upside potential for the single currency.
Yield Spread Analysis:
Another reason why we remain bearish on EUR/GBP is the yield spread. The 2-year (short term) spread between German and UK government bond yields remains in a downtrend. UK 2-year yields are now 59 basis points above the German 2-year. Although the spread narrowed earlier this week, it failed to get above the prior May high, which suggests that the upside in German yields could be limited and we could see further downside.
As you can see in the chart below, the yield spread and EUR/GBP tend to move closely together. Yield is a contributing factor to a currency’s value, so when yields are low it can limit a currency’s upside. We believe that German yields could remain low for the medium-term, especially if the ECB announces new easing measures at next week’s meeting, which could cut short EUR/GBP’s recovery.
The Technical View:
If this cross fails to get above 0.8158 – Fib resistance – then we could see an extension of the recent sell-off. Key support lies at 0.7960 – the November 2012 low.
Figure 1:
Figure 2:
Source: Bloomberg and FOREX.com
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