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Time to Forget the Euro-Pound Trade?

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It's been a great time to be long the euro against the British pound. So far this year, the euro has rallied 6 percent against its counterpart across the Channel, and broken out of a longtime range.

Don't expect the good times to last, says Camilla Sutton, chief currency strategist at Scotia Capital.

"Technically the near-term EURGBP outlook is still bullish, but we think fundamentally it is stretched and in the medium term should fade lower," she wrote in a note to clients.

You wouldn't know it to look at the relative health of the British and euro zone economies. Scotia Economics expects 2013 GDP growth under 1 percent in Britain - and a slight GDP contraction in the euro zone. But currency trading is about expectations, and Sutton argues that "there is too much good news priced into the European economic outlook and too much bad news priced into that of the UK."

By the same token, Sutton says expectations for the European Central Bank and the Bank of England have gotten out of whack. "The market has become too aggressive in its expectations for the BoE" in terms of adding monetary stimulus, she says, and if investors are disappointed, the euro will sell off.

That's not all. Investors have been piling back into euro zone assets now that fear of the sovereign debt crisis is abating. But Sutton expects those flows to slow, removing yet another pillar of support for the euro.

Sutton recommends selling the euro against the pound at 0.8620, setting a stop at 0.8900 and a target of 0.8155.

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