GBP/EUR testing 1.20 but upside limitedGBP/USD approaching 1.30 & vulnerableFed minutes, balance sheet plan up next

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Pound Sterling rose sharply against a broadly softer Euro during the opening half of the week but could struggle to advance by much beyond the nearby 1.20 level and remains at risk from a stronger Dollar as market attention turns to Wednesday’s Federal Reserve (Fed) meeting minutes.

Sterling was on course for a hat-trick of gains over the Euro on Wednesday after G7 countries and the European Union proposed fresh sanctions over alleged Russian atrocities in Ukraine including proposed bans on entry for Russian ships and trucks as well as on purchases of Russian coal

Such measures would further undermine the Russian economy but may also be costly for western countries and especially those in Europe where economic links with Russia are deeper, potentially explaining why the single currency has been among the biggest fallers thus far in the new week.

“EUR/GBP has now fully reversed the late-march rally,” says Chris Turner, global head of markets and regional head of research for UK & CEE at ING.

The Russian government has described the allegations about Bucha, Ukraine, and events underlying them as a “monstrous forgery” but western countries have taken a ‘hit first and ask questions later’ approach in their response by reaching immediately for the sanctions stick.

Above: Pound to Euro exchange rate shown at hourly intervals alongside EUR/USD.

“Rising political risk in the eurozone ahead of the French elections can keep some pressure on the pair, although Cable may continue to edge lower on the back of good dollar momentum and negative impact on GBP from new sanctions against Russia,” ING’s Turner also said on Wednesday.

Uncertainty about the outcome of a looming April presidential election in France has also most recently been cited by some analysts as a potential weight on the Euro, which also remains susceptible to any potential pivot in Europe to consideration of sanctions on Russian oil and gas.

LIVE Follow my report to the European Parliament on the European Council of 24-25 March #EUCO #Ukraine https://t.co/WCWbLr3dwk

— Charles Michel (@eucopresident) April 6, 2022“As the war in Eastern Ukraine carries on, and the risks of an energy supply shock linger, we think both the EUR and the GBP are vulnerable,” says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

“We continue to believe that EURGBP's fundamental valuation will become stretched in the 0.82/0.83 range [GBP/EUR: 1.2048/1.2195],” Gallo said in a market commentary on Tuesday.

Above: Pound to Euro rate shown at daily intervals with spread, gap or differential between 02-year UK and German government bond yields as well as selected moving-averages. Click image for closer inspection.

Developments in and around Ukraine remain an important driver for the Euro but it and the Pound to Dollar rate will also be sensitive on Wednesday to the contents of minutes from the March meeting of the Federal Reserve.

“According to a survey by the New York Federal Reserve in January, market participants expect the balance sheet to shrink by $US2½tn. We consider the risk lies with a less aggressive run‑off. The USD may weaken in response to a less aggressive balance sheet run‑off,” says Kristina Clifton, a senior economist and currency strategist at Commonwealth Bank of Australia.

The U.S. Dollar has been lifted broadly, adding to declines in GBP/USD and EUR/USD after two U.S. policymakers warned that the Federal Reserve could elect as soon as next month to begin shrinking its near-$9trillion balance sheet quicker than financial markets have given credit for.

Those statements came ahead of Wednesday’s release of minutes from the March Fed meeting, which Chairman Jerome Powell previously said would contain details of the bank’s plan for the process known as “quantitative tightening” including the size of the targeted monthly balance sheet reduction.

This is an upside risk to U.S. government bond yields and a likely further downside risk for the Pound to Dollar rate and European single currency.

Above: Pound to Dollar rate shown at weekly intervals with Fibonacci retracements of 2020 recovery indicating possible areas of medium-term technical support for Sterling, and including GBP/USD’s 200-week moving-average. Shown with EUR/USD.