The euro extended its advance against sterling for a sixth session on Thursday, with the cross testing last week\u2019s highs near 0.8645. Over recent days it has gained nearly 0.9% and is set for its strongest weekly showing since May, a move largely driven by broad-based pound weakness. Softer UK inflation data on Wednesday reduced expectations of a near-term Bank of England rate rise, while uncertainty persists over how Prime Minister Andrew Burnham\u2019s cabinet will fund its spending pledges, adding to concerns about fiscal stability.<\/p>\n
The euro held a firmer tone ahead of the European Central Bank policy decision. Commerzbank expects no move at this meeting, but still projects the next step would take the policy rate to 2.50% in September. The bank also points to the ECB\u2019s updated forecasts due by then, which could inform any subsequent tightening, while cautioning that the single currency may struggle to derive much support from this meeting unless the guidance turns more hawkish.<\/p>\n
We see strong bullish momentum for the Euro against the Pound as it tests the key resistance level at 0.8645. Given this sixth consecutive day of gains, we suggest derivative traders look at short-term EUR\/GBP call options to capture further upside. This rally has pushed the pair up by nearly 0.9% this week, driven by a growing policy gap between the two central banks.<\/p>\n
The British Pound remains under heavy pressure due to soft UK inflation and worries over the new cabinet’s spending plans. To hedge against further Sterling weakness, we recommend buying out-of-the-money put options on the Pound. Historical trends show that fiscal uncertainty can quickly trigger a 2% to 3% drop in currency value when bond markets react negatively to unbacked spending.<\/p>\n
With the European Central Bank decision looming today, implied volatility for EUR\/GBP has ticked up to around 6.8%. We advise traders to consider a long straddle strategy to profit from sharp price swings if the ECB delivers a hawkish surprise. Even if they hold rates today, any strong signal pointing to a September rate hike to 2.50% will likely push the Euro toward 0.8700.<\/p>\n
Over the coming weeks, we must closely monitor the open interest in September Euro contracts, which has already risen by over 10%. If the Euro fails to break past 0.8650 after the meeting, we should pivot toward range-bound strategies like iron condors. Keeping tight stop-losses is highly recommended to protect our positions against sudden shifts in political sentiment.<\/p>\n\n\n\n