29th May - Watch Sterling beat the Euro
01 June 2015
TECHNICALS:
Weekly chart
The market has broken three major levels of support.
This is a major breakdown.
Daily chart
This short-term catalyst for the bears is a completed bear parallel flag.
The retracement to the lower diagonal of the flag (good short-term resistance) is, we believe, a selling opportunity.
FUNDAMENTALS:
The recent correction in Sterling/Euro, was driven by two factors:
In the event, the Fed Chair Janet Yellen has cleared the uncertainty over US interest rates by declaring last week that US interest rates will start to gradually rise from this year; a comment that has helped the Dollar and turned the spot light back onto the Euro zone, Greece and the Euro.
Turning to the UK, the election produced a surprise Conservative majority government which removed much, but not all, uncertainty afflicting the Pound. Although the Conservatives are no longer in partnership with the Liberal Democrats and thus free to pursue the policies outlined in their election manifesto, the feeling is that the core of UK economic policy will not be too different in this Parliament from the last.
That means traders can now focus more on economic fundamentals and less on political risk.
Although UK Q1 GDP has cooled a little, there are signs of strength: last week’s strong retail sales suggest that Q2 will see a stronger result. This, together with still-low inflation and historically low interest rates, is positive for the Pound. Especially when compared to the still-weak economic performance of the Euro zone economy.
Add to that the continued uncertainty generated by Greece, and the Euro remains a fragile currency for any lingering Euro bulls.
But all is not plain sailing for the Pound. The UK government has promised an in/out referendum on the UK’s continued membership of the EU. Yet although there is a strong chorus that constantly calls for a UK exit, it doesn’t necessarily represent the majority of public opinion.
In fact, we think that David Cameron knows this. His decision to call a referendum is more likely a strategic play to silence those Eurosceptic voices both within and without the Conservative party. This is a smart move since the last Conservative administration under John Major was constantly dogged by in-fighting over Europe.
So how big an issue is the EU referendum for Sterling right now?
Currently we don’t think it’s that big. The Prime minister has only just begun his attempt to renegotiate the UK’s relationship with the UK’s EU partners. He won’t set a time table for the referendum and the associated campaigns until he judges he has achieved all he can by renegotiation.
Moreover, we won’t really have a good idea about public opinion until the pollsters start publishing regular opinion polls.
Since the referendum is expected in late 2017, we don’t think the Pound is currently trading on the probabilities of that event.
So for now, the main dynamics likely to drive Sterling/Euro over the medium term are the Strength of UK growth compared to that in the Euro zone, the level of UK inflation and what that means for UK monetary policy and the health of UK public finances.
And these all currently favour a stronger Sterling performance against the Euro.
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5th June - Is it all over for US Bonds? 
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26th May - The UK Gilt - Is it vulnerable?