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EURGBP update: UK-German yield spread reaches multi-year high

Updated -  May 13, 2014 9:20:00 AM By Kathleen Brooks



This cross has fallen to fresh lows today as a mixture of weak German ZEW data and a 17-year high in the UK- German yield spread weighs heavily on the single currency. We pointed out HERE that 0.8160 was a key level of support (the 61.8% Fib retracement of the July 2012 to Feb 2013 bull trade), this has been breached today, which suggests that we could see further losses for this pair.

The yield effect

Yields matter, as they are a good indicator of how much a currency is worth. A troika of factors are weighing on European yields and the EUR, including: 1, expectations of ECB policy accommodation in June, 2, some weakening in European data and 3, a sharp decline in sovereign debt fears in the currency bloc.

The UK-German yield spread has widened to 127 basis points, which is the highest level since 1997. When spreads get stretched to these multi-year highs it is wise to use caution. On the one hand, this spread is already at a 17-year high, how much further can it go? Added to this, EURGBP is down some 7% since September last year, isn’t it time for a rebound? However, on the other hand, why would the spread not move higher if the UK Inflation Report on Wednesday suggests that a rate hike is sooner than we thought and if the ECB cuts rates in June and signals that there could be more to come?

From an FX perspective, EURGBP has taken a battering in recent months, but there could be further to go on the downside. We have only retraced 61.8% of the July 2012 – March 2013 bull trend, as we mention above. In Fibonacci terms, breaking below the 61.8% level is serious, and suggests that the bias is still to the downside. On July 24th 2013 EURGBP fell to 0.7755, so there may be further room for this cross to fall.

If the yield spread continues to move in the UK’s favour, EURGBP could break the 0.80 handle in the medium-term and the 2012 lows could come back to haunt us.

Figure 1:

Source: FOREX.com

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