EUR/GBP: 4 Reasons a Drop May Be Imminent

The month of December has been quite the wild ride for the EUR/GBP as it has carved out a herky-jerky move higher as 2014 comes to an end.  Not much has changed in the overall perception of either currency with the European Central Bank and President Mario Draghi contemplating Quantitative Easing to start the New Year and the Bank of England’s Governor Mark Carney overly concerned with the lack of inflation. 

While the everyday volatility has been more extreme than usual, the total pip flow from top to bottom in this currency pair is just over 140 pips; a small window in comparison to some of the more free flowing and volatile pairs out there.  However, when one considers that the value of one pip is typically 1.5 times that of the major pairs, the lack of volatility can be more easily stomached.  Therefore, looking at the EUR/GBP at current values provides for some intriguing potential for future volatility lower.  Here are four reasons a drop may be imminent.

Potential Double-Top

One of the easiest technical patterns to identify is the double top, where an instrument rises to a previously established high and then has an extremely difficult time getting back above that point.  While not always foolproof, it can help to identify where a potential “running out of steam” may occur for an advancing instrument.  The 0.7980 level appears to be a candidate for a potential double-top, but there’s more…

Figure 1:

Source: www.forex.com

Top of Potential Trend Channel

Since the low set in early December, the EUR/GBP has been carving out a messy rising trend channel that hasn’t respected the bottom very well, but has adhered to the top so far.  If it continues to follow this channel, a drop down to 0.7920 seems ideal, and considering the lack of respect for the bottom of the channel so far, could extend below it if prompted.

Figure 2:

Source: www.forex.com

Potential Bearish Butterfly Pattern

The 0.7975 level corresponds closely with  a pair of Fibonacci extensions that converge and form a Bearish Butterfly Pattern which could spell out a top in this currency as well.

Figure 3:

Source: www.forex.com

ECB vs. QE

To come up with a fundamental argument as to why it would be a logical idea to sell the EUR against virtually every other currency on the planet (save the RUB) is not a very difficult task.  A quick scan of economic releases, reading some economic news literature, or even listening to the ECB’s Draghi gives the impression that the Eurozone is about to implode.  Draghi’s hints about QE possibly being instituted in January were direct and not meant to be misinterpreted, but the market is giving pause anyway – hence the reason the EUR has strengthened.  As we get closer to the end of the year though, many EUR bulls may begin to lose their boldness and retreat to safer pastures.

Despite the reasons listed for a currency drop to be imminent, it is important to remember that markets don’t always act as they seem like they logically should, so it is important to manage risk accordingly and be prepared for the worst case scenario.