Truss U-turn and end of BoE support bring EURGBP back into view

[MongiIG]

Between a mini-budget reversal and the end of the Bank of England gilt support, EUR/GBP looks to continue its reversal after recent volatility

Source: Bloomberg

 Joshua Mahony | Senior Market Analyst, London | Publication date: Friday 14 October 2022 

Truss and Kwarteng expected to reverse key budget policies

It has been a rollercoaster start to Liz Truss’ time at Number 10, with the contravertial mini-budget bringing major volatility and instability for the UK. The sharp spike in UK bond yields led to emergency intervention from the Bank of England, which is due to come to an end this week. Despite calls from the Pension and Lifetime Savings Association for that support to be maintained until or “possibly beyond” 31st October, Andrew Bailey has pushed back and maintained todays deadline. With Liz Truss expected to announce a reversal of the plan to cut corporation tax later today, we have seen yields correct heavily, to the benefit of risk assets. The chart below highlights the importance of yields to market sentiment, with the decline in UK and US 10-year treasuries bringing downside for the haven dollar. However, while we have seen some short-term downside for the dollar, it is worth noting that the trajectory remains upwards for both yields and the dollar.

Source: TradingView

With fears around whether we will see an orderly end to the Bank of England’s recent intervention, and the prospect of a reversal in course for UK public expenditures, it will be worth watching the pound closely today. Whilst the prospect of higher corporation tax could be bad for growth, we have already seen that markets appreciate its influence on government debt and inflation. Stripping out the haven dollar demand element, it is worthwhile watching EUR/GBP. The pair has seen a huge reversal since that post-budget peak of 0.9284. Since then, the pound has been in charge, pointing towards a potential return back towards the lower boundaries of this six-year range.

Source: ProRealTime

The four-hour chart supports the notion that we could see further downside, with price forming a head and shoulders pattern over the past month. Thus far we have seen price break through the 0.8645 support level formed on 4 October, but we now have the neckline to contend with. However, even without that break, we are looking at a market that has gone from higher lows to lower lows since falling back through the 0.8691 level. For now, a break below the H&S neckline (currently 0.8600) would bring the potential for another leg lower. Conversely, any near-term pop in price would be deemed a selling opportunity as long as price does not push through the latest swing-high of 0.8867.

Source: ProRealTime