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EUR/GBP rebounds as outlook on sterling remains dim

H.S. Borji
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The EURGBP rebounded on Friday, as a weak British pound failed to extend its rally for a second consecutive day amid growing concerns about Scottish independence.

The euro-to-pound exchange rate advanced 0.21 percent to 0.7943, easing off an intraday high of 0.7973. The pair faces initial support at 0.7889 and resistance at 0.7980.

The euro plunged 1 percent against the pound on Thursday following a surprise announcement from the European Central Bank. The ECB adopted a more aggressive approach to combat low inflation, including cutting interest rates for the third time since November and introducing new stimulus measures.

The ECB lowered its target for the overnight rate to 0.05 percent from 0.15 percent and said it would begin purchasing asset-backed securities. The size of the ECB’s quantitative easing program is estimated to be worth up to €500 billion.

On the data front, the European Commission confirmed the Eurozone economy was flat in the second quarter, as geopolitical tensions in the east weighed on the 18-nation collective.

Compared to the second quarter of 2013, Eurozone gross domestic product grew 0.7 percent in the second quarter, the EC confirmed today.

Separately, German industrial production rebounded sharply in July, raising hopes the Eurozone’s star economy was rebounding after contracting 0.2 percent in the second quarter.

German industrial production jumped 1.9 percent in July, following a gain of 0.4 percent the previous month, official data revealed today. Economists forecast a gain of only 0.3 percent.

Compared to July 2013, industrial production advanced 2.5 percent.

In UK data, consumer inflation expectations in the next year edged up to 2.8 percent from 2.6 percent, the Bank of England revealed today. Inflation is expected to rise 2.8 percent in the next two years, the report showed.

Additionally, nearly one-half of all Britons said they expect the central bank to raise interest rates in the next 12 months. The BOE kept its target for the overnight rate at 0.5 percent at the most recent policy meetings held on Thursday.

The pound’s inability to extend its rally against a defensive euro speaks volumes about investors’ appraisal of the British currency. The pound has struggled in recent months in response to a cooling UK economy. One of the biggest areas of concern is wage growth, which continues to trend well below inflation levels.

Weak earnings growth prompted the Bank of England to cut its wage growth forecast for the year, as policymakers adopted a softer stance on interest rates. This is likely the biggest factor behind the pound’s decline. Low wage growth effectively eliminated the prospect of a 2014 rate-hike, which the pound bulls were banking on over the past several months.

Most forecasts say the UK economy will grow more than 3 percent this year, which means the BOE will likely begin raising interest rates in early 2015. According to economists in a recent Reuters poll, the BOE will raise interest rates a few months before the United States Federal Reserve.

Adding to the pound’s recent woes is the upcoming referendum on Scottish independence. A latest YouGov poll found that 47 percent of Scots were in favour of independence, which has raised uncertainty in the global markets.

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