Last week we sent the long GBPUSD trade setup and we said that, although fundamentally short EURGBP also looks very attractive, the technical picture wasn’t as clear as on GBPUSD. But today, that has changed as EURGBP broke the neckline of a bearish head and shoulders pattern. The details for this new setup are listed below.

GBPUSD update:

In the meantime, GBPUSD broke the trendline that we highlighted as key resistance. Yet, it obviously occurred before the Fed (tonight) and BOE (tomorrow) events, something we noted as a prerequisite that we want to avoid. The potential volatility still makes GBPUSD a riskier trade before these events have passed; hence it’s still better to avoid taking the trade ahead of them. 

However, the bullish break of the falling trendline last Friday does suggest some bullish bias in GBPUSD. And, for example, if the Fed disappoints today, then this long GBPUSD could work very well, especially because the BOE may surprise hawkishly tomorrow (see why below). All in all, the potential remains for GBPUSD to rise toward the 1.35 target we specified, but it will be key how the market reacts to the Fed tonight and the Bank of England meeting tomorrow.

This morning’s UK CPI inflation report was scorching hot. It printed considerably above expectations, just a day before the Bank of England meets. To give you the specifics, headline y/y CPI rose by 5.1% (vs 4.8% exp), while the core CPI climbed 4.0% (vs 3.7% exp). This is up from the previous month’s 4.2% and 3.4% readings and 3.1% and 2.9% in October, respectively. 

Rate hike pricing in futures markets has jumped as a result (until this morning, consensus expectations were for no hike), meaning it has now become more likely that the BOE will hike tomorrow! The bank was already worried about inflation in October/November and was already talking about rate hikes back then. However, the appearance of the Omicron variant changed that, and BOE officials changed their tone to more dovish in recent weeks. 

So, the Omicron variant is the biggest (if not the only) reason why the BOE may disappoint again and not deliver the rate hike. But, even if they don’t hike, the scope for GBP to sell off on a dovish disappointment is quite low because GBP has been depressed down and oversold for a while. This means that GBP will likely see a much stronger (bullish) reaction in case of a hawkish BOE than it would fall in case of a dovish BOE. Thus, this is why we think a short EURGBP trade is worth taking even before tomorrow’s Bank of England.

On the ECB front, we can expect much less volatility as they will not make any big decisions or announcements. Moreover, they remain one of the most dovish central banks, which should keep the euro anchored on the weak side in Fx. A dovish ECB coupled with a BOE that hikes tomorrow could easily push EURGBP back down towards the 0.84 level or below.

The change in GBP momentum is evident on the charts too. Notably, EURGBP broke the neckline of the head and shoulders pattern this morning following the release of that CPI report (see chart below). 

Also, the head and shoulders is located near the upper end of the bearish daily channel that has been steadily pushing EURGBP down since April. Technically, this increases the probabilities that resistance will hold and that the neckline break is genuine. It seems the trend here is ready to continue here, and EURGBP could take another leg down.

The break of the H&S neckline puts a clear target of around 100 pips to the downside, as measured with the height of the head. This comes in at the 0.84 zone and is the target for this trade.

Entry:

• Short entry around current levels (0.8495) or, if possible higher and closer to the broken neckline (above 0.85)

Stop:

• Above 0.8550 (the previous swing high)
• A tighter stop can be placed around 0.8520 (the neckline), but in this case, the risk is greater for the stop to be taken out on a fake volatile move.

Targets:

• The 0.84 zone - Projected target of the H&S pattern