GBP/EUR Week Ahead: Bank of England Can Deliver Multi-Year Highs

• GBP/EUR at highest levels in months
• Bank of England is week's key focus
• Could hint that the time to talk about rate cuts is coming
• But for now, expect push-back against rate cut talk
• This can support GBP over coming days

Above: File image of Governor Andrew Bailey. Image: OeNB/Gruber. Reproduced under CC licensing.

In the coming week, the Pound to Euro exchange rate could break to new multi-year highs or flop back below the 1.17 level again.

The tantalising prospect of the best levels since early 2022 for Euro buyers means there is a lot riding on this week's Bank of England decision, which comes as the exchange rate tests a massive resistance zone between 1.17 and 1.1775.

The chart below shows that we have reached the thin air that forms the 2023 range top: the exchange rate is uncomfortable here and liable to gravity.

Above: Daily chart showing GBP/EUR price action.

Pound-Euro's recent rise above the 1.17 level follows a double combination of last Wednesday's solid UK PMI print and Thursday's 'dovish' European Central Bank guidance, which resulted in broad-based Euro weakness.

We would not be surprised if Pound-Euro slipped back below 1.17 in the lead-up to Thursday's Bank of England decision amidst an abundance of caution amongst investors fearing another failure at resistance.

But, should the Bank of England successfully repeat the message that UK interest rates are to stay higher for longer, the Pound-Euro could finally break higher to levels last seen in 2022 above 1.1775.

It is worth reminding readers of last week's important article on the matter, where strategists at Westpac are betting on a break to fresh highs for the Pound while the long-suffering GBP bears over at Macro Hive say it is time to bet on a return into the 2023 range.

Analysts at Danske Bank also don't fancy the Pound's chances of making recent gains stick, looking for the Euro-Pound to recover: "In our base case, we expect EUR/GBP to move higher on softer guidance and updated projections."

As mentioned, the Bank of England is front and centre for the Pound at the start of February, and analysts we follow reckon now is the time for policymakers on the Monetary Policy Committee (MPC) to signal interest rate cuts lie ahead.

How strong this signal of an impending 'pivot' is will determine how the Pound trades: go too far and markets will ramp up rate cut bets and sell the Pound.

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One only needs to recall that it was an apparent lack of pushback by the ECB's Christine Lagarde last Thursday that saw investors raise bets for an April rate cut, which resulted in a Euro sell-off.

"The reality is that defending a 'higher for longer' stance on interest rates is getting harder to defend as the inflation backdrop shows signs of improving," says James Knightley, Chief International Economist at ING.

ING expects the Bank will drop the suggestion that it could raise rates further, but keep the signal that rates need to stay restrictive for an extended period.

"As for the vote split, we suspect the hawks will finally throw in the towel and stop voting for a rate hike. At the same time, we think it’s probably too early to see the doves voting for a cut. That leads us to expect a unanimous decision to keep rates on hold," says Knightley.

We can't gauge the extent the market shares these expectations, so it is hard to tell how such an outcome would impact the Pound.

We suspect if the MPC vote split sees more than one member vote for a cut, the Pound would struggle.

Likewise, a deep cut to the Bank's inflation forecasts in the Monetary Policy Report to sub-2.0% over the 1-3 year horizon could be equally negative.

On the other side, the Bank could well push back against market rate cut bets, leaning on December's uptick in inflation, January's strong PMI report and fears of renewed inflation stemming from attacks on Red Sea shipping.

"Ahead of the February BoE policy meeting, the markets are pricing in more than three rate cuts in 2024. In our view, this still represents a relatively dovish policy outlook and we believe that the updated economic forecasts, policy statement and the MPC voting split could encourage investors to pare back their rate cut expectations some more," says a note from Crédit Agricole.

If this call is correct, we would anticipate the Pound to end the week on a strong note, potentially testing the upper limit of the 2023 range at 1.1775.