Sterling Update: GBP/EUR at its highest since August 2022

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GBP

Sterling rounded up on a strong note at the end of May, with GBP/EUR peaking at 1.1780, the highest level since August 2022. However, this peak still indicates a resistance level, similar to last summer’s high, suggesting that significant market events may be needed to push past this psychological position. The pound was up against most other major currencies, including the dollar, which saw GBP/USD jump over 3 cents in three weeks up to just under 1.28. A key factor behind the pound’s improvement appears to be the Bank of England’s changing stance on interest rates. With the UK’s headline inflation dropping to 2.3%, slightly higher than expected, it has pushed back the chances of an early interest rate cut from the Bank of England. In our May market update, we reported market predictions of over 50% in favour of a cut at June’s MPC meeting. Expectations have now reduced to less than 10%, with some forecasters believing August or September is when the base levels will be dropped from the current 5.25%.

Meanwhile, UK politics continues to see activity from both the Labour and Conservative parties in the lead-up to the 4th July election. In a recent political tussle last week, long-serving Labour member Diane Abbott has confirmed she will be standing as a Labour candidate following a row that overshadowed much of the campaigning last week.

Historically, the pound tends to underperform ahead of political events*, as seen over the years with Brexit and other election events. This pattern suggests that we might see the pound fall away from the recent highs. Either way, after relatively little volatility so far this year, more movement could be on the cards.

*The Sunak-Truss leadership contest saw a 1.5 cent drop for GBP/EUR in the lead up to the decision in September 2022.

EUR

The European Central Bank (ECB) became the first major central bank to cut interest rates yesterday, in a move widely anticipated by markets. Policymakers cut rates by 0.25% marking the first rate cut by the ECB in five years and signalling the end of the monetary tightening cycle that began in July 2022. The decision followed the Bank of Canada’s decision to also reduce rates on Wednesday 5th June. Although EU inflation has dropped by over 2.5% since September 2023, inflation is expected to stay above target well into next year. Policymakers revised their inflation projections for the Eurozone raising forecasts for both 2024 and 2025 from 2.3% to 2.5% and 2% to 2.2% respectively. Economic growth is projected to improve, reaching 0.9% in 2024, 1.4% in 2025, and 1.6% in 2026.

ECB President Christine Lagarde’s subsequent comments appeared to express ongoing caution and indicated that monetary policy would remain restrictive for ”as long as necessary”. She emphasised the Governing Council’s commitment to ensuring inflation returns to its target of 2%.

There was little reaction from the euro as the cut was already priced in thanks to the clear, ongoing narrative from EU policymakers that has helped stabilise expectations around interest rate changes.

From an interest rate and economics perspective, it is possible the EU and Canada could start a chain reaction as we witness the first interest rate cuts in the developed world. The UK, US, and Europe had previously followed similar monetary policy trends when both raising and holding rates. If these cuts are well received and avoid any economic scrutiny from markets around their decisions, it could open the door to rate reductions from many other countries.

To finish the week, this morning saw the release of the latest quarterly GDP growth data from the EU. As expected, growth remained stagnant at around 0.3%.

None of the information contained in this document constitutes, nor should be construed as, financial advice. All rates are sourced from Bloomberg.