EUR/GBP edged higher on Tuesday as the Pound softened on renewed doubts over the UK’s fiscal outlook following Andy Burnham’s appointment as Prime Minister and the naming of John Healey as “the chancellor of the exchange”. The cross was trading around 0.8527 at the time of writing, with a recent slide having taken it to its lowest level in a year. Comments about using “any flexibility” within fiscal rules were linked to fresh pressure in the gilt market.
The Euro drew support from stronger ZEW releases: Eurozone Economic Sentiment rose to 23.4 in July from 9.5 in June, beating a forecast of 11.2, while Germany’s index increased to 26.3 from 10.5 versus expectations of 18. In the UK, employment grew by 147K in the three months to May after a prior 100K gain, and the ILO Unemployment Rate held at 4.9% against a 5.0% forecast. Markets are now focused on Wednesday’s UK CPI and PPI data.
Derivative Positioning for EUR/GBP Rebound
We believe derivative traders should position for a steady rebound in the EUR/GBP pair over the coming weeks by targeting the 0.8700 level. With the pair currently hovering near its one-year low of 0.8527, the downward momentum appears to be losing steam. We recommend buying EUR/GBP call options or utilizing bull call spreads to capture this reversal while protecting against sudden downside.
Our view is supported by growing fiscal jitters in the UK following the political transition to Prime Minister Andy Burnham. His comments on using “flexibility” within fiscal rules have already unsettled bond investors, pushing the UK 10-year gilt yield up toward 4.3%. This fiscal uncertainty is bound to keep the British Pound under pressure, limiting any further gains for the currency.
Meanwhile, Eurozone economic data is showing surprising resilience, providing a solid floor for the Euro. Recent July ZEW Economic Sentiment data surged to 23.4 from just 9.5 in June, while German sentiment easily beat expectations by jumping to 26.3. This economic divergence makes EUR/GBP put options less attractive and supports our preference for upside exposure.
Managing UK Data and Volatility Risk
We must also prepare for immediate volatility with the crucial UK inflation data release scheduled for tomorrow. Historically, unexpected drops in inflation during periods of political change have triggered sharp sell-offs for the Pound. Traders should consider using short-dated straddles to exploit the potential price swings around this major data release.
