British Pound Heads for Break

By Jul 29, 2009, 11:51 AM Author's Blog  

For the past four trading days, the British pound has been stuck in a 200 pip range against the U.S. dollar and a 115 pip range against the Euro. However the bottom of the range in both the GBP/USD and EUR/USD have been broken, leading currency traders to wonder if the larger range will be tested as well. For the GBP/USD, this would be a break of the 1.6750 or 1.60 level and for EUR/GBP, the levels to watch are 85 and 87 cents.

Despite the 1 percent drop in the EUR/USD today, the GBP/USD has been relatively unchanged. One month GBP/USD volatilities have fallen to the lowest level since September 2008. Such a sharp contraction in volatility usually suggests that a breakout is imminent. The only question is, in which direction. Here are some sound arguments in favor of an upside or downside breakout.

Arguments for upside breakout in GBP/USD

  • Housing market continues to show signs of stabilization, house prices rise for first time in 2009
  • Break of 86 cents in EUR/GBP could lead to GBP buying
  • Ascending triangle formation
  • Moving averages are in “perfect order” which favor a new uptrend

Arguments for downside breakout in GBP/USD

  • Risk appetite is waning, which could drag all of the higher yielding currencies lower
  • U.K. Banks could be set for losses as clock ticks on GBP300bn commercial property loans
  • Q2 GDP was very weak
  • Risk of Bank of England increasing asset purchase program
  • GBP/USD breaks 4 day low

Given the arguments, we believe that the chances of a downside breakout is greater than an upside one. Based upon the following chart, a break of near term support should come soon at which point, the next level or support or resistance would be the highs and lows of the past 2 months.

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