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FxWirePro: Euro Gaining Momentum Against Sterling Ahead of ECB, What Drives EUR/GBP Uptrend?
ECB is scheduled for their monetary policy this week, with the EURGBP continuing to stand above 0.8950 levels ahead of today’s ECB monetary policy meeting, the European central bank is all set to publish details on the allocation of its PEPP programme and focus will be on the potential skew towards Italian and French government bond holdings.
EUR crosses have rebounded (especially, EURGBP, EURJPY) after Germany announced a bigger-than-expected €130bn stimulus package including a temporary cut to VAT this year to boost spending.
The performance of GBP has been relatively mid-range within G10 over the past week amid a lull in headlines, but next week will likely be more eventful with the next round of UK-EU negotiations beginning June 1 (the European Council meeting is then scheduled for June 18- 19). The last round of talks didn’t indicate much progress on the key issues of disagreement. An extension appears highly unlikely, in our view, which pushes up the odds of a no deal given the rushed timeline for difficult negotiations (our economists currently put this at 35% assuming no transition extension vs. their prior estimates of 25%). Our own sense is that the market might price this as a more averse 50:50 scenario, in which case fair- value for cable would probably drop to the high teens (we would expect cable to fall to between 1.10-1.15 under a no-deal EU exit).
Brexit issues aside, other structural motivations remain intact for GBP shorts against EUR:
1) the scale of the damage to public sector finances ‒ the deficit is estimated at a conservative 16% of GDP this year, and potentially more if the government struggles to wind-down its labour market furlough scheme;
2) the actions of the BoE in providing QE to absorb the government issuance ‒ we expect at least a £100bn extension next month, but this could be as high as £150bn and so take total purchases to a potential 16% of GBP;
3) the possibility of the BoE going negative on rates later in the year ‒ the curve now prices a move to -5bp next year;
4) no other negative rate country has a current account deficit ‒ the UK has one of the largest of any major economy.
On trading perspective, at spot reference of EURGBP: 0.8950 levels, contemplating above explained technical rationale, it is advisable to trade one-touch call option strategy using upper strikes at 0.9050 levels, the strategy is likely to fetch leveraged yields as the underlying spot FX keeps spiking further towards upper strikes on the expiration.
Alternatively, ahead of ECB monetary policy that is scheduled today, long hedges via EURGBP CME futures of June deliveries are activated with an objective of arresting foreseeable upside risks. Courtesy: JPM