EUR/GBP at a Critical Juncture

The sell-off in the euro ahead of monetary policy meeting tells us that some traders are hoping for immediate action in the form of support for Italian banks or an extension of the end date for bond purchases but we feel that the chance of a short squeeze in EUR/USD post ECB is stronger than a steep sell-off. First, speculators are very short euros according to the CFTC’s latest report and this explains why the move to 1.10 has been slow. Secondly, the ECB just eased in March and began their Targeted LTRO program on June 22nd. Throughout this period, they have said they need more time to assess the full impact of stimulus and we expect this view to remain true in July. Had financial conditions tightened post Brexit the ECB would feel greater urgency to act but the German DAX is close to recovering all of its Brexit losses and the VIX which measures volatility in stocks dropped to its lowest level since 2014. The weakness of the euro provides automatic stimulus to the economy, which means the ECB can afford to wait. So the potential for an initial short squeeze is high if the central bank stands pat and the outlook thereafter will depend on how strong of a message the ECB sends. Of course, if they ease tomorrow in any shape or form, euro will make a run for 1.09, dragging all euro crosses including EUR/GBP down with it. Sterling on the other hand soared today thanks to healthier employment numbers but these numbers will not alter the central bank’s plans to ease.

Technically, the picture is murkier. With today’s decline EUR/GBP has fallen below two key Fibonacci levels – the 50% Fib of the 2008 to 2015 decline and the 23.6% Fib retracement of the May to July rally. For now the pair is holding above the 20-day SMA, but if drops below today’s low of 0.8339, a deeper correction the 38.2% of this year’s move appears likely. If it holds the moving average, we should see a move back above 84 cents.