In recent weeks, the big rally in the Euro relative to Sterling has slowed and been showing signs of preparing to reverse course. Between last week’s big ECB stimulus announcement and this week’s Bank of England meeting, we could see a shift in sentiment between the two currencies.
Through December and January, EURGBP soared up from near 0.7250 toward 0.8000 before running into resistance. Over the last month, however, signs of exhaustion and topping have emerged. A head and shoulders top has formed with shoulders near 0.7850 and the head near 0.8000. In addition to failing at a round number, a negative RSI divergence appeared at the head indicating upward momentum was starting to fade.
A lower high carved out the right shoulder while RSI has continued to fall indicating a turn in momentum. The pair has started to drift back toward 0.7700 a key support level where a Fibonacci cluster, the neckline of the head and shoulders top and the 50-day average converge. Meanwhile, the RSI is testing 50 suggesting momentum has shifted from positive to neutral with a downturn pending.
A break of 0.7700 by the pair would complete the head and shoulders top and signal the start of a new downtrend while a break of 50 by the RSI would signal a downturn in momentum. Next potential downward support levels appear near 0.7620 then the 0 7500 round number.
The weakness in GBP relative to EUR, USD and other currencies was driven by to main factors, both of which appear to have been fully priced into Sterling now.
First, The Bank of England backed away from planning to raise interest rates in the first half of this year, moving from a hawkish to neutral stance. This week the Bank of England is expected to maintain monetary policy. With the ECB having gone more dovish bringing in a new round of stimulus last week, a neutral to hawkish stance by the MPC and Governor Carney could support a continued rebound in GBP while a surprise dovish turn could set Sterling back again.
Second, the announcement of the EU deal and Brexit referendum date sparked a wave of bearishness against GBP. This selloff was overdone and overblown with the vote still so many months away and as initial skittishness fades, GBP has started to rebound.