EUR/GBP drops to two-week lows, closer to mid-0.8500s ahead of ECB

• EUR/GBP witnessed some selling on Thursday and retreated further from multi-week tops.
• The downfall could be attributed to some repositioning trade ahead of the key ECB decision.
• A combination of factors might act as a headwind for the GBP and help limit deeper losses.

A sudden pickup in demand for the sterling dragged the EUR/GBP cross to two-week lows, closer to mid-0.8500s during the first half of the European session.

Having repeatedly failed to find acceptance above the 0.8600 mark, the EUR/GBP cross witnessed some selling on Thursday and retreated further from seven-week tops touched earlier this week. The intraday slide lacked any obvious fundamental catalyst and could be solely attributed to some repositioning trade ahead of the highly-anticipated European Central Bank meeting.

The recent surge in the Eurozone inflation to the highest level in over a decade prompted hawkish rhetoric from a host of European Central Bank (ECB) policymakers. It, however, is still not clear that there is a majority in the governing council about the gradual scaling back of the stimulus. This turned out to be a key factor that acted as a headwind for the shared currency.

Meanwhile, the British pound's relative outperformance comes amid the UK-EU stand-off over the way forward for the Northern Ireland Protocol. In the latest development, the NI's Democratic Unionist Party (DUP) leadership reportedly withdraws from some cooperation with the Republic of Ireland under the 1998 Belfast agreement in protest over the Brexit Protocol.

Adding to this, the DUP’s Chief, Sir Jeffrey Donaldson, warned the DUP could not continue in Stormont if the “protocol issues remain”. This, along with British Prime Minister Boris Johnson's plans to introduce a new 1.25% health and social-care levy on earned income, should hold the GBP bulls from placing aggressive bets and help limit losses for the EUR/GBP cross.

Even from a technical perspective, the EUR/GBP cross has been oscillating in a range over the past three weeks or so. Heading into the key central bank event risk, this further warrants some caution for bearish traders and makes it prudent to wait for some follow-through selling before confirming that the cross has topped out in the near term.

Technical levels to watch