The EUR/GBP Trend Is Worth Your Attention

by: Joshua Brown

Competing Economies

For the most part, the EU and the UK can be lumped together in terms of a trading block in competition for capital with the United States and despite the UK never adopting the euro, it is undeniably tied to the Eurozone. The euro and the pound usually trade in high correlation against the USD however, they do break away on differing monetary policies, stock market performance and other economic events (including rumors). Therefore, before trading the EUR/GBP, it's prudent to assess the correlation first. If the EUR and GBP have a low correlation, it's important to investigate the underpinning causes - it may be that they will continue for some time. Take note that the GBP/USD is a more volatile currency pair and that in times of booms and bears it will move more wildly than the EUR/USD. Currently the GBP/USD and EUR/USD is trading at a 0.93 correlation over the past year, which is quite strong, but trading at a -0.09 correlation on the weekly chart (which is rather low). According to analysts, this is due primarily due to recent positive economic data coming out of Europe and conversely ineffective UK data releases including a higher-than-expected decline in retail sales in January and hints the cash rate will remain unchanged. Broadly speaking, there are signs that the EU is recovering with the UK tagging along and thus the EUR/USD should push on in its fresh upward trend (outpacing the GBP and ultimately converging with the GBP in price performance over the coming months). The German indicator of economic health, the IFO business climate report was released today and its positive result confirms this contention. Both currencies will benefit from the overall weakness of the USD.

Over the long term, analysts do see a higher level of confidence growing in the euro countries compared to the UK and this will lead to a higher rate of capital inflow. In the lead up to the Scottish referendum, we should view the GBP with added uncertainty.

As we can see from the chart below (Bloomberg), we notice the divergence of the currencies in price performance (the UK did have a great start to the year) however, we may see the orange and green lines in the chart uniting again in the coming months as the EUR picks up traction.

Trading the EUR/GBP

Most believe it is impossible to predict the market, so if you're considering trading the EUR/GBP, it may be useful to place trades long and short with a bias towards a higher EUR.

A trader looking to place a long position might see the EUR breaking out of its downward trend and place a buy at about 0.833 after allowing the price to move through a narrow channel. This would allow enough room for the price to confirm the breakout.

A trader looking to place a short position might see the EUR/GBP continuing the downward trend after coming close to the lower resistance line. A short position might be placed at about 0.83 with a stop loss placed at the higher parallel resistance line. The profit target would be about ~0.80 to ~0.81 or at a level around the downward sloping support line.

It's the bigger picture

In summary, due to their high correlation, it may be a good idea to trade the EUR/GBP with monetary policies in mind. However, it is not the only major differential. The euro and the pound are both competing for capital inflow and therefore confidence building results will decisively increase a currency's value . There are some important GBP announcements coming out tomorrow, it may be worthwhile to check up on those to form your own opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.