Daily Insight

Sterling has been increasingly volatile in recent weeks, with a tug of war developing between the technical and fundamental outlooks. Add to this the impact of shock news, and you have a recipie for a jittery and directionless market. There have been three major factors affecting the pound since late May, each exerting a force on the market. Let's break it down;

The market was already trending gently upwards (stronger sterling) in late May when the French and Dutch announced their rejection of the EU constitution. This put a rocket under sterling, and the pound rallied from 1.4400 to 1.5130 over the next month, a major move by any standards. The momentum was firmly underpinned by the fundamentals. Dissapointment over the failure of the EU constitution weakened the outlook for Euros Vs Sterling, and the market reacted in a fairly logical manner. The French and Dutch "no votes" has not been expected, which explains the market's severe reaction as it lurched sharply higher, rapidly discounting the new situation into the exchange rate.

Just when things were looking super-positive for sterling, in late June the Bank of England revealed their new bias toward interest rate cuts. This took the market by surpirse, and the obvious effect of an imminent rate cut was quickly priced in. Rate cuts make sterling a less attractive asset versus other currencies, thus the value of sterling declined against the Euro, and we saw pretty much the exact opposite of the reaction to the "no" votes. The market rapidly started to discount the fact that interest rates have now peaked in the UK, and the cycle has turned down for the first time in two years. Most analysts expect this cycle to bottom out arounf 3.75% against today's 4.5%. The BoE cut rates by a quarter point yesterday, and we may see one further 0.25% cut by the end of the year.

The third factor driving sterling lately is of course the terrorist attacks in London. The initial reaction saw sterling lose another 1.5% against the Euro, falling from 1.4700 to a low of 1.4515 on the 7th July. Since then sterling has failed to take back any of the loss, and we are now trading at 1.4380.

The technical outlook is mixed. There is a long term "double bottom" pattern forming, with the "neckline" at 1.5250. This suggests that if sterling can manage to close above 1.5250, the target becomes 1.6700. This looks a long way off from currenct levels, and the target doen not come into play until the neckline is broken, so this formation could prove to be a false dawn. Indeed, the fundamentals do not appear to support a strong case for sterling rising to 1.6700. However, technical analysis teaches us that "anything can happen".

How does this bode for people looking to buy Euros in the short term? Well, these is little chance of seeing 1.5250+ within the next three months, so I would be looking to employ a risk management strategy to ensure that the worst case scenario is known before you make your currency purchase. No one knows aexactly what the market will do over the next few weeks, and with so much uncertaintly hanging over currency markets at present, you will do well to take a risk based approach to your currency transactions.

There is some chart support at 1.4300, so Euro buyers may want to consider placing a "stop order"** close beneath here, so that they are protected form a sharp downside move, while allowing them to hold on for higher rates if sterling can find some strength over the next few weeks.

** A stop order is a mechanism that protects against an adverse market movement. If the stop price is reached, the transaction is completed automatically.