Trade of the Week | April 23-27, 2012

Recent trade of the week (TOTW) posts have featured one currency pair stuck in a trading range (EUR/USD) and another pair which showed potential to establish a new trend (USD/JPY). This week's selection is a pair that's been trending for some time.

The EUR/GBP currency pair has been moving from the upper left to the lower right of the weekly chart over the past several months. On 18 April, the minutes of the 4 & 5 April Bank of England (BOE) Monetary Policy Committee (MPC) meeting showed that über-dove Adam Posen refrained from voting in favor of further boosting the central bank's asset purchase programme, leaving just one Committee member (David Miles) seeking more quantitative easing . The British pound reached a new 20-month low against Europe's common currency the following day. Below is a weekly chart for the pair as it looked at last Friday's close.

As I stated in this preview of the UK GDP report, "It is not uncommon for sterling's post-release move to defy the logic suggested by comparison of the GDP headline number to the consensus forecast." During Wednesday's London session, that report showed the UK economy had entered recession, and the subsequent British pound sell-off lifted the euro pound to a key level.

I discussed in the FX Bootcamp News Room, and have illustrated on the chart below, the technical case for buying the pound against the euro at or just below 0.8220.

In addition to a retest of the red trendline -- defined by the 28 March and 3 April highs -- as well as the 9 January and 16 April lows, traders who employed the Fibonacci tool saw a 61.8% Fib retracement level of the drop from high #1 to low #2 parked a smidge below the horizontal blue line. The EUR/GBP touched the 0.8220 level on two occasions, once about 30 minute after the GDP release, a second time about 90 minutes after news. Although closing the short trade at about 5:00 pm London time on Wednesday was a viable exit strategy, it wasn't unreasonable to let this one run.

Why would traders seek to buy the pound? It's not as if economic fundamentals in the UK are unusually strong. The key is understanding that currencies are relative. Sterling likely benefits by comparison to other options. The eurozone's woes are well-documented, and yields in peripheral European government bond markets remain uncomfortably high; Britain, meanwhile, has a head start on mainland Europe in reducing its government debt, and yields on UK 10-year Gilts remain near all-time intra-day lows established earlier this year.

The European Central Bank (ECB) recently distributed more than €1 trillion in cheap funds to euro zone banks via two long-term refinancing operations, while the odds of more easing by the BOE are diminishing as UK inflation begins to appear stickier. As the highest level of unemployment in the 17-nation eurozone since the euro's launch (article) tempers aggregate demand in that economic region, the forthcoming Diamond Jubilee and Olympic Games could give the UK economy a boost in summer.

Got your own pick for TOTW? Post it in the comment section!

Curt Wehrley
Twitter: @fxcoachcurt
Currency Coach & Quantitative Analyst
FX Bootcamp

Related posts:
April 16-20 Trade of the Week
April 9-13 Trade of the Week
April 2-6 Trade of the Week
March 26-30 Trade of the Week
March 19-23 Trade of the Week
March 12-16 Trade of the Week

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