Long EUR/GBP in summer markets - Nomura

Analysts at Nomura suggest that given the event risk of Friday’s US CPI, they prefer to trade the long EUR view via EUR/GBP where, on a relative output gap view, as they think it has further to run.

Key Quotes

“We’ve been more optimistic on GBP than most and the trade worked to begin with until the round of BoE inflation reports that discussed higher rates but ultimately disappointed. It would take a lot for the market to change its “Brexit bias”; even the sound of the UK accepting a transition period did little to turn the tide. The data picture remains mixed and so your view on the UK and GBP depends on which data you put weight on (a topic on lambda Mark Carney has touched on before). It’s not just a question of lambda (the trade-off between growth and inflation) but also the interpretation of the overall impact of higher inflation.”

“Enter long 31 October EUR/GBP 0.92/0.94 call spread

• The disappointing BoE scenario that unfolded last week means our view that UK real rates will eventually improve has been postponed, and short-term selling pressure on GBP is likely to persist with next week’s data unlikely to change the narrative. 
• Given the event risk of this week is Friday’s US CPI number, to avoid the volatility around this release GBP may be used more as a funder for long EUR trades rather than USD. In the vol space the spread between EURGBP and EURUSD skew has narrowed to its post-financial-crisis lows and EURGBP implied vols have fallen below EURUSD. This means the relative value between choosing GBP or USD as a funder for long EUR is more balanced than we’ve seen in the post-Brexit era. 
• Therefore, the risk-reward in the short term is to enter long EUR/GBP here at 0.9025 and enter a 31 October 0.92/0.94 call spread for 0.51% EUR premium with a max payout of 4.2 to1. 
• In the medium term the onus is now on the data to lead to our Economics team’s view of a November rate hike from the BoE. If the data come in line with market forecasts it is hard to argue against the view of higher EU rates vs UK on a relative output gap differential which would be EUR/GBP supportive for the time being.”