European Central Bank’s decision impacts EUR – Sterling Update

GBP

The Bank of England (BoE) surprised some (but not all) with their decision to maintain UK rates at 5.25% this week. The move marked the first pause in rate hikes from the BoE after 14-straight increases and came after recent figures confirmed an unexpected faster slowdown in inflation during August, which had encouraged several analysts to change their predicted outcome to a pause for this meeting. The decision was a very close call, with five Monetary Policy Committee (MPC) members voting for a pause, against four voting for a 25bps rate hike.

During his post-meeting press conference, BoE Governor Andrew Bailey said; ‘inflation has fallen a lot in recent months, and we think it will continue to do so.’ Despite the good news for UK borrowers, Bailey warned against a ’premature celebration’, given that there is still a long way to go before inflation reaches the BoE’s longstanding target level of 2%.

Furthermore, with the recent rises in energy prices expected to increase headline inflation over the coming months, a cautious welcome to the news seems sensible. Much the same as the Federal Reserve (Fed), the BoE warned that moving to a pause should not mean that the chances of any imminent rate cuts have materially increased.

The news will also be good news for the government, who have been burdened with existing debt interest payments. The government will have also welcomed confirmation on the same day that the latest government borrowing requirements came in under the OBR’s March expectations.

The pound slipped to a multi-month low on the BoE news, with GBP/USD moving under 1.2300 for the first occasion since April, and GBP/EUR slipping to a two-month low under 1.1530. GBP/USD has been under intense selling pressures of late, consistent with other major currencies against the resurgent dollar.

EUR

Last week’s decision by the European Central Bank (ECB) to raise Euro area interest rates by another 25bps has done little to halt the decline for the single currency. During that time, ECB officials have continued to highlight the prospect for further rate hikes in the region, given that inflation is not falling ‘at the desired pace.’ Markets have focused on the outlook for the region’s growth, which is likely to remain constricted, as incoming economic data signals the potential for further weakness.

Market-implied prospects for further ECB rate hikes in this environment have therefore diminished significantly, even if the ECB are still suggesting otherwise. EUR/USD yesterday (Thursday) hit a cycle low of 1.0616, a level not tested since March. The pair is now heading towards a tenth-straight week of declines, its worst weekly run since 2014. Perhaps the best chance of a reversal in EUR/USD might currently be the dollar reaching exhaustion point, after such a long and powerful rally (see USD).

Regional inflation data will be the major highlight among incoming economic data for next week. With energy prices rising sharply, headline Consumer Price Inflation (CPI) could be vulnerable to an upside surprise, when September’s preliminary figures are released. Germany release their latest inflation updates a day beforehand. Today’s (Friday) Purchasing Managers Index (PMI) updates are likely to reflect softness across the region, with the ongoing softness among manufacturing morphing into a previously-resistant service sector.