Where Did It All Go Wrong?

Unlike George Best I am not talking about the fruits of a successful football career, rather I refer to my forecast for Stg at the start of Q2. As part of my ‘’ sackcloth and ashes’’ penance, I will remind you of what I said in my blog back then ‘’ While I expect choppy range trading to continue over the quarter, my view has shifted from buying Stg on the dips to selling it on the rallies’’.

I also suggested that .8150/60 would be an attractive level for Stg sellers and that we should see a test of .8400/20 which buyers would likely find attractive.

In my defense (which come to think of it is no defense at all) the Eur/GBP high was .8400 and we only broke down through .8150 on the 21st of May, however since then we have seen little or no pull back from the jet propelled pound.

So what if anything has changed?

The economic releases in general have been very positive and supportive of Stg, they show an economy that is forecast to grow at 3% in 2014 and 2.5% in 2015 (HM Treasury, comparison of independent forecast). The only economic indicators that are causing concern are CPI, which dropped to 1.5% in May. This measure of inflation has now been below the Bank of England’s 2% inflation target for a sustained period. In addition wages growth is also a concern for the MPC.

The May release of the wages data shows the average weekly earnings, including bonuses, growing at a disappointing 1.7% on an annual basis.

So we have an economy that is growing nicely but without a hint of inflation, actually with more than a hint of deflation in some areas of the economy, but overall if you are the Bank of England you are probably as worry free as a central banker can ever be!

Therefore it came as quite a shock for the market (against the backdrop described above) and to me when in his Mansion House speech on the 12th of June, Governor Mark Carney indicated that the first rate hike could come earlier than markets had been pricing in. The Market’s reaction to this bombshell was to price in the first UK rate hike in November 2014.

That pretty much put paid to many forecasts (so I am in good company) for Stg. The currency reaction was to immediately strengthen and we were quickly testing .8000, the bounce from here was hardly worthy of the term as the Eur/Gbp rally petered out at the .8035 level and since then we have traded a narrow range between .7905 & .8020. The currency pair is now comfortably trading under .8000.

YTD 2014 EURGBP Performance

The ‘likely’ trading range for Q3!

I find it difficult to make the case for sustained Stg strength against the Eur from here as we are unlikely to see many positive surprises from economic data releases, many of the releases are at such elevated levels that a negative surprise cannot be ruled out.

CPI & wages growth are likely to remain weak and the market having priced in a rate rise in November is unlikely to bring that date forward, if anything any data releases softer that forecast could see interest rate rises pushed back again to early 2015. I have been here before, haven’t I? I am in danger of convincing myself that Stg is about to weaken! Mustn’t do that!!

So what could cause Stg to strengthen? We should not forget the Eur in Eur/Gbp. The data out of Europe is at best unconvincing and deflation is an ongoing concern not just to the periphery states but also to the core countries - the ECB may be forced into decisive action to generate inflation and to weaken the currency. This presents a real threat to the Eur/Gbp currency pair, the possibility of ECB action may limit Eur/Gbp upside to what is now a key resistance level at .8150/60.

It will also have to overcome significant resistance at .8035 along the way. So how low can the Eur/Gbp trade to, that is dependent on the extent of any ECB action, if we go with premise that they usually disappoint then the very strong support at .7750/75 (last traded in July 2012) should limit the downside. So I am going with a range of .7750 to .8160 for Q3, I may well be wrong in my forecast as they teach you in Market’s kindergarten, currency forecasting is ill-advised.

However, ignore that pearl of wisdom, I do! And let me know your forecast and thoughts for Stg in this quarter. Please use the comment box below to share your thoughts on the currency.

Past 2 Years EURGBP Performance



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