Sterling Update: The pound fell against the euro in the aftermath of inflation data

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GBP

Last week saw sterling up on multi-month highs against the euro and US dollar. This week started on the back foot, with the pound losing some but not all of the gains.

GBP/EUR has been hovering around 1.15 this week, while GBP/USD recovered from 1.26 up to 1.27 levels.

Some of the gains we saw last week may have been held by the overly hawkish Bank of England statements following its rate decision last Thursday. Although the central bank opted to hold rates steady, three members of the Monetary Policy Committee voted for a 25-basis point hike despite many economists suggesting this was unnecessary.

Suren Thiru, economics director at the chartered accountancy firm ICAEW, went as far as to say the Bank of England was “unnecessarily hawkish“, and it was clear that further hikes would only have a negative effect on the economy – which has already seen some poor performance recently.

It follows growth data released earlier last week when we saw the UK economy unexpectedly shrink by more than expected to -0.3% in October, down from 0.2% growth in September. Data today (Friday 22nd December) also indicated that the UK economy shrank between July and September when the Final GDP figure was revised lower to -0.1%, below the 0.0% forecast. GDP is now set to come in up just 0.2% compared to the end of last year.

As we approach the festive season, market data is significantly lighter this week compared to last week. The first major release was on Wednesday, when the UK’s latest CPI inflation data was released, showing that price rises slowed more than expected. The monthly inflation rate fell to 3.9% in November, well below the expected level of 4.4% forecast by a Reuters poll and significantly lower than October’s 4.6%. Inflation is now at its lowest since September 2021. Inflation across the EU and the US is currently sitting at 3.1% and 2.1%, respectively.

The pound fell against the dollar and the euro in the aftermath, seeing around a half-a-cent drop for both currencies, with GBP/EUR sitting at the three-week low, as markets increased bets that the Bank of England would cut interest rates in 2024. The first interest rate cut is now fully priced in by May next year.

The top contributors to the slowdown in price increases were transport, recreation and culture, and food and non-alcoholic beverages.

The UK’s Retail Sales data for November was also released this morning, growing more than expected. Markets had forecast growth of 0.4% in the run-up to Christmas after two months of contraction. However, the data came in far above expectation at 1.3%.

Although the GDP and Retail Sales data failed to impact the currency market significantly, sterling rose against the dollar and euro in the immediate aftermath.

EUR

Last week was very positive for the EUR/USD currency pairing. It gained 3 cents from 1.07 to 1.10, representing the euro completely regaining its losses against the dollar since its peak at the end of November. Because the currency pair has now touched this position a few times over the last few weeks, it is now considered the new resistance level. Resistance levels represent a point that currency pairs have difficulty moving past because supply then begins to outweigh demand.

At the beginning of this week, we saw the euro lose 1 cent against the USD since last Friday, in part due to the continued pause on interest rates from the European Central Bank earlier in the week but also from the slight underperformance in the Purchasing Managers Index (PMI) from France, Germany and the EU as a whole.

French flash manufacturing and services PMIs both landed lower than expected at 43.3 and 44.3, respectively, and down from last month’s readings. The German flash manufacturing PMI came in as expected at 43.1, and the services PMI was below forecast at 48.4. All the data still points to business activity falling below the key 50 level, which distinguishes growth from contraction.

There were minimal data releases this week, which saw a flatter week from the single currency in the lead-up to the end of the year. However, the currency market does tend to be less liquid around the festive period, which can increase volatility.