Euro strength worry for ECB

The euro’s minor recovery on the back of stronger-than-expected Eurozone inflation data this morning last only a few moments. After climbing to above 1.19 on news of an unexpectedly sharp 1.5% year-over-year rise in August CPI, the EUR/USD then tumbled 50 pips after Reuters reported, citing an unnamed source, that the ECB is growing worried about the recent strength of the euro and that this may increase the chance of a delay or call for a more gradual exit from the asset purchases programme.

If the strength of the euro is indeed becoming a headache for the ECB, then this bodes well for our bearish view on the EUR/USD pair we wrote about yesterday. But ahead of the US nonfarm payrolls report on Friday, the EUR/USD may turn choppy. Therefore, those interested in trading the single currency may prefer to watch the euro crosses, such as the EUR/GBP.

As far as the EUR/GBP is concerned, there has been a lot said about the possibility for it to hit parity. While this is still possible, I am not quite sure if it will get there. The pound’s underperformance since April has been chiefly due to the political turmoil in the UK and the fact the Bank of England refused to turn hawkish despite UK inflation rising above the Bank of England’s target. At the same time, economic data in the Eurozone started to improve which aided the euro’s recovery. But the EUR/GBP may be overvalued now. The BoE may be forced to raise interest rates in the event UK inflation unexpectedly accelerates further, or wages start to catch up with prices.  The euro could fall if the ECB refuses to announce a plan to taper its QE programme in the coming months, and even if it does the move could be priced in by then. So I think the upside for the EUR/GBP is limited, but given the ongoing Brexit uncertainty I wouldn’t be surprised if the exchange rate eventually rises to 1.00.

But for now, the EUR/GBP’s rally appears to have stalled. It formed a doji candlestick pattern after an extended bullish run, on Tuesday. With the momentum indicator RSI also being around the ‘overbought’ threshold of 70, and the fact that price has subsequently held below the doji candle, this is characteristic of bearish price action. What’s more, broken support levels such as 0.9250 and 0.9235 have turned into resistance. And while the moving averages may be in bullish order, price has moved significantly above the 200-day average, which increases odds for a reversion to mean.

That being said, none of the key support levels have broken down yet. The most important support in my view is around the 0.9110-0.9140 area, which was formerly a significant resistance zone and where we have the 21-day exponential moving average coming into play. If this support area eventually gives way then we may see a more significant drop. Until that happens, one has to treat this latest sell-off as a normal pullback in what still is a bullish trend. Indeed, any move back above that doji candle candle’s low of 0.9250 would invalidate the short-term bearish bias.