EUR/GBP up up and away as markets position for hard line EU/UK negotiations

EUR/GBP has been on the front-foot in the later stage of the week with a comeback in the euro, (50% mean reversion in EUR/USD), and a lower pound as investors position in month-end flows ahead of formal EU/UK trade negotiations kicking off in March. At the time of writing, EUR/GBP is trading at 0.8519, between a range of 0.8427 and 0.8542. 

Sterling is not far behind commodity-FX in terms of weakness on a daily basis this week as investors pair back long positions in the build up to trade negotiations between the UK and Europe. In recent news, the UK has warned the EU it will walk away from trade talks in June unless there is a "broad outline" of a deal.

On Thursday, Michael Gove told MPs the UK wanted to strike a "comprehensive free trade agreement" in 10 months. But the government would not accept any alignment with EU laws as the EU is demanding, with Mr Gove adding: "We will not trade away our sovereignty." As both sides set out ambitious priorities, the prospect of a hard Brexit is being priced back into the pound. 

"We think this is likely to sour sentiment toward the pound once again. We see additional upside risks for the pair and look for a move toward 0.86," analysts at TD Securities argued. 

Eyes on BoE, USD weakness and the March budget

The Bank of England’s steady hand in January was accompanied with dovish commentary. Due to the coronavirus spread, the post-election surge in UK business confidence and ongoing strength in the labour market could come under pressure if the virus were to travel across the channel to the island. Such an event would see risks tilting back towards a BoE rate cut in coming months, given the UK economy will also feel some impact from a global slow down regardless.

However, the euro has rallied on the dollar's weakness and a correction would likely weigh on the cross. DXY has completed a 38.2% Fibonacci retracement back to an area prior resistance which could act as a support and potentially weigh on the euro. However, there is growing assumptions in the market that the Federal Reserve could cut rates as soon as next month. According to the CME watch, the odds of a rate cut have jumped from 33% yesterday to a 72% probability today – it is now a toss-up between risk-off flows and the Federal Reserve. On the other hand, the coronavirus risks seem not to have been priced into the euro fully. Considering the borderless eurozone, the risks of contagion are particularly high in Europe. Despite that, there were some stronger Business Climate numbers and the Economic Sentiment Indicator was also higher. 

Meanwhile, the new chancellor is expected to raise taxes in his first Budget or he will be breaking the government's rules on borrowing, a leading economic think tank has warned and this too is weighing on the pound. Rishi Sunak is under pressure to increase spending on the NHS, social care and schools. He has also inherited a fiscal target from his predecessor Sajid Javid to bring spending in to balance by 2022. The BBC reports, however, "the Institute for Fiscal Studies has suggested this will not be possible without increasing taxes. It said that loosening or abandoning the rules, set out in last year's Conservative election manifesto, would undermine the credibility of any fiscal targets the government set."

EUR/GBP levels