In our previous review back in August, we showed that the long-term yield difference between the German bund and UK gilts are somewhat going hand in hand with the EUR/GBP exchange rate. And we suggested that further upside in EUR/GBP likely, given the yield divergence. We maintained our target of 0.94.

While the yield spread topped in late August, the EUR/GBP exchange rate moved higher to peak in early October around 0.92 area. Current our short-term short call in EUR/GBP is active, which was given around 0.89 area with a target around 0.85. The decline in yield spread from -0.63 percent to -1.18 percent has helped in achieving the short side target. As of now, we don’t suspect major declines in the exchange rate, however, a lower yield spread likely to keep up the pressure on the euro against the sterling.

What might affect the yield spread significantly going forward?

• ECB’s announcement of further stimulus.
• Further easing from the Bank of England.
• Inflationary outlook in the United Kingdom due to a weaker pound.