EUR/GBP nears key support level

Dollar rallies across the board

On Tuesday, the euro recorded again heavy losses across the board and closed down for the fifth session in six. This time, it was an unexpected decline in EMU (core) inflation that fuelled further speculation that the ECB will have to ease policy beyond recent measures. EUR/USD lost again more than one big figure and filled bids well below 1.26 intraday, before some minor dollar profit taking left the pair at an 1.2631 close. At the same time, the dollar remained well bid: USD/JPY closed 15 ticks higher at 109.65 and cable lost slightly ground. US eco data were okay, but nevertheless fell short of high expectations. Any dollar disappointment was rapidly swallowed.

Overnight, dollar strength remained the eye-catcher. USD/JPY is upwardly oriented and set a new cycle high at 110.09, before retreating a bit. EUR/USD is somewhat lower (1.2618) and so is cable. The Tankan (Japan) business sentiment was mixed. Large manufacturers showed slightly increased confidence, but large non-manufacturers reported a weaker outlook. The difference is probably due to weak yen (manufacturers/exporters) and sales tax (non-manufacturers). Markets were not convinced and USD/JPY set a new 6-yr high, which triggered official warnings (Economics minister) that excessive FX moves are undesirable. Broad-based USD strength is also very visible in heavy losses overnight of the Aussie, Won, Kiwi and Loonie. Trade weighted USD is above 86 (resist. 88.70).

Later today, EMU PMI, US ISM and ADP report will retain our attention (see FI part for a more extensive assessment). For the final September EMU PMI, we expect no upward revision (50.5). It would confirm the dreadful situation of the EMU economy. Poor details from France or from peripheral countries could be a (slightly?) additional negative for the euro. For the US, we see upside risks for the ISM that is expected to have slipped from cycle highs in August (58.5 from 59).
Similarly, there are slight upside risks for the ADP employment that is expected little changed at 207 000. So, we expect the US data to confirm the strong growth momentum, which should be dollar supportive, especially against the euro. However, after yesterday’s sell-off and the sharp declines in previous sessions, EUR/USD losses are already heavy. Even more, big further broad-based dollar strength might become self-destroying, as markets start speculating the Fed might postpone or slow the eventual Fed policy normalisation. However, this point has not yet been reached. For now, the euro downtrend/USD uptrend remains in place.

From a technical point of view, USD/JPY extended its rally after the break of the 105.44 resistance and now approaches the key 110.66 resistance, amid nervousness of Japanese authorities that the yen weakening is becoming too fast. US eco strength and expectations that the normalization of Fed policy nears supports the dollar. The yen remains on the defensive as markets see a decent chance of more BOJ easing down the road. We have a positive view on USD/JPY. There is no reason to row against the tide, but in the short-term some consolidation/correction is still possible.

The technical picture of EUR/USD deteriorated further after the break below the key 1.2662 support level (Nov 2012 low). A confirmation via a second close below this level is still needed, but will most likely be registered today. We are a bit surprised by the fast pace of the EUR/USD decline. Evens so, the trend remains in place and there is no reason to row against the tide. The 1.2043/1.1877 support comes in the in the picture as the LT target.

EUR/GBP nears key support level

On Tuesday, sterling was pushed back and forth both by domestic and external factors. The latter had the biggest impact. Cable felt some spill-over effects from the sell-off in EUR/USD and dropped (temporary) below the 1.62 mark, before closing at 1.6213, a slight decline from Monday’s 1.6232 close. At the same time, sterling outperformed the euro which was more or less in free fall due to the unexpected fall in EMU core inflation. EUR/GBP settled well below the 0.78 barrier, setting an intraday low at noon (0.7766), before some profit taking on sterling kicked in and the pair settled at 0.7790 in the close. The key 0.7755 support is definitely on the radar.

Today, the UK manufacturing PMI is expected unchanged at 52.5. The index already lost some ground in spring and the decline accelerated in the summer. For now, the strong performance of the UK economy is mainly driven by the services sector. Even so, a new negative surprise for the manufacturing PMI could weight on sterling. This applies in the first place to cable. Regarding EUR/GBP, after the recent sell-off and with the key 0.7755 support nearing, a break below the key support probably needs a substantial divergence in the eco data between the EMU and the UK in favour of the latter.

Underlying sterling sentiment against the euro is good. Short-term, we might see a slowdown in the EUR/GBP decline as the 0.7755 support looms. Further down the road, the focus for sterling trading should return to the economic fundamentals and to the guidance from the BoE on policy normalization.