EUR/GBP to Remain Under Pressure as Yields, Terminal Rates Favour Sterling

Short EUR/GBP – Contingent Upon Stubborn Core CPI

• EUR/GBP appears vulnerable after recent failure to break above near-term resistance.
• Yields and interest rate differentials point to a more supported pound sterling at a time when the ECB’s hawk Klaas Knot issued an uncharacteristically dovish message around the uncertainty of future rate hikes. Bund yields fell sharply
• The analysis in this article makes use of chart patterns and key support and resistance levels. For more information visit our comprehensive education library

EUR/GBP Downtrend to Continue

EUR/GBP reveals a reluctance to trade and hold above the intra-day level of resistance at 0.8613 – a level which has preceded multiple moves lower since June. Upon a close lower, EUR/GBP could be headed for another move towards 0.8520, with the first test of bearish momentum to be overcome at 0.8565. Resistance appears at 0.8635.

Of course, early on Wednesday morning we shall receive UK inflation data with all eyes on core inflation which has picked up in the most recent two months – in contrast to the UK’s peers – prompting a step up in the magnitude of rate hikes. Markets now anticipate the likelihood of another 50 bps hike in August but this will ultimately be influenced by tomorrow’s figures with a hotter print likely to underpin faster hikes. A welcome print lower ought to bring about a lower repricing in sterling and ease expectations of future rate hikes.

EUR/GBP Daily Chart

Source: TradingView, prepared by Richard Snow

Bank of England (BoE) rate expectations now see more than 64% chance of another 50 bps hike which would take the UK bank rate to 5.5%. However, the bigger story here is that markets anticipate more than 100 basis points to come, meaning the terminal rate could be somewhere at or above 6% before the BoE stop hiking.

Market Implied Probabilities of Future UK Bank Rate

Source: Refinitiv, prepared by Richard Snow

On the other hand, the European Central Bank (ECB), is expected to hike once, possibly two more times before topping out at 4%. However, markets were shocked today to hear comments by well-known ECB hawk Klass Knot that the outlook for rate hikes beyond July appear uncertain. Subsequently German bund yields fell. The ECB will have to be very deliberate in its messaging after next week’s rate setting meeting to avoid mass speculation.

Market Probabilities for the ECB Policy Rate

Source: Refinitiv, prepared by Richard Snow

Risk events ahead include the UK inflation data, final core inflation for the EU and manufacturing PMI in Germany which has sunk to 40.6 – a stark reminder of the global slowdown with affects being felt in Europe’s manufacturing hub.

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— Written by Richard Snow for DailyFX.com

Contact and follow Richard on Twitter: @RichardSnowFX