GBP/EUR Week Ahead Forecast: Soft Tones Into Budget and ECB Decision

• GBP/EUR trending lower near-term
• Wednesday's UK budget main event for Pound Sterling
• Thursday's ECB rate decision eyed by the Euro

Image © Gov.uk

Pound to Euro exchange rate weakness will likely persist through early March, particularly if the UK budget is not well received midweek and the European Central Bank strikes a hawkish tone on Thursday.

Last week saw Pound Sterling endure its biggest weekly decline against the Euro since mid-December (-0.30%), as it extended its retreat from the February 14 peak at 1.1767, a 25-week high.

The sell-off has been a gentle one, in line with the low volatility environment that has beset the broader foreign exchange market in February, and we expect any upcoming weakness to be relatively shallow.

What looks key to us is the horizontal support line at 1.1660, a level we expect to hold in the near term owing to a lack of major data releases in the UK and Eurozone this week as the low-volatility environment endures.

Above: GBP/EUR at daily intervals, showing near-term supports. Track GBP/EUR with your own custom rate alerts. Set Up Here

If support holds, we would be confident that a rally to the 1.17 level, a fulcrum for price action in February, will transpire.

However, given the placid nature of this exchange rate right now, anything more ambitious would only occur later in the month.

A potential trigger for bigger moves would be Wednesday's UK budget announcement and Thursday's European Central Bank (ECB) policy meeting, the only events worth speaking of on the Pound-Euro's calendar.

We reported recently that if Chancellor Jeremy Hunt gets the March 06 budget wrong, the Pound could fall by as much as 2%, but analysts say the Pound would find some positives if a credible fiscal easing is announced.

Furthermore, any efforts to boost UK productivity, such as business investment tax breaks, can also result in a stronger Pound.

The big risk for the Pound is if the Chancellor announces big tax cuts deemed unaffordable by bond market players, as was the case with Liz Truss' botched budget of September 2022.

ING estimates a 40 basis point risk premium in 10-year gilt yields, "suggesting markets aren't totally immune to UK fiscal risk".

Above: ING's models suggest the Pound is undervalued against the Euro.

"Were Chancellor Hunt to misread the mood of gilt investors and cause another upset, sterling would again come under pressure," says Chris Turner, Global Head of Markets at ING. "Short-term models suggest a 2% sell-off in sterling could happen quite easily were investors again to demand a risk premium of sterling asset markets."

The Euro rose on Friday following the release of stronger-than-expected Eurozone inflation data, which suggests to markets that the ECB will push back against any talk of an imminent move to cut interest rates on Thursday.

The data revealed that service inflation pressures remain acute in the Eurozone, prompting the ECB to say it wants to see softer wage dynamics (which would weigh on service inflation) before cutting interest rates.

Maitreyi Das, Global Economist at HSBC, says investors will closely watch for any
forward guidance on the timing of the first rate cut. "We don’t think the ECB will be confident enough that the eurozone has gone far enough 'along the disinflation process' even to discuss rate cuts."

"While headline inflation has fallen, core inflation remains higher than the ECB would like and real wages remain high. We expect the first rate cut to come in June," she adds.

The rise in the Euro through the previous week betrays a market positioned for a relatively 'hawkish' ECB, which would mean the upside risks to the Euro on the day are limited.

This means the surprise factor would be if the ECB condones expectations for a mid-year cut, arguing it believes inflation is still on course to hit 2.0% sustainably.

This would likely result in a weaker Euro and prompt a Pound-Euro retest of 1.17.