Pound to Euro Exchange Rate Buttressed by Bank of England

Image © Adobe Images

Pound Sterling could be set for a run higher against the Euro into year-end thanks to the Bank of England's November guidance.

The Pound to Euro exchange rate rose after the Bank cut interest rates by 25 basis points but raised inflation and growth forecasts for 2025 and said a gradual approach to cutting interest rates was still appropriate.

This lowers the odds of a December interest rate cut and ensures UK interest rates are likely to maintain a premium on those in the Eurozone, where rates will likely come down again before the end of 2024.

"Gradual easing supports a stronger GBP," says Kirstine Kundby-Nielsen, FX analyst at Danske Bank.

"Today’s BoE update is supportive for the pound," says Lee Hardman, an analyst at MUFG Bank.

"Unlike the ECB and Fed, the BoE remains comfortable for now to stick to plans for gradual rate cuts. With yields in the UK set to remain at relatively higher levels at least until early next year, the pound is set to remain attractive as a G10 carry currency," he adds.

The Bank's Monetary Policy Report (MPR) revealed new economic forecasts, which also provide a crucial message to markets. Internal economists raised the forecast for inflation at the all-important two-year horizon by 60 basis points to 2.2%, which is an admission that the Bank won't achieve its 2.0% target on a sustained basis.

Investment bank consensus forecasts update: The end-2024 and 2025 guide from Corpay has been released. It shows a sizeable uplift was made to the consensus forecasts for GBP/EUR. Please request a copy here.

To achieve the 2.0% target, the Bank will have to cut interest rates on fewer occasions than it assumed in its August MPR update.

Economists at Pantheon Macroeconomics now look for the Bank to cut its base lending rate by 25bp in February, May and November, taking it to 4.0% at end-2025. Previously, Pantheon saw four cuts in 2025.

"The pound's rebound should be encouraged by today’s BoE policy update, which, alongside the US election outcome, has increased downside risks for EUR/GBP heading into early next year," says MUFG's Hardman.

Above: The market has lifted its expectation of where the interest rate cutting cycle will end.

The Pound to Euro exchange rate rose following the U.S. election result which handed Donald Trump another term, while his Republican Party took control of both the Senate and House of Representatives. Markets judge Trump's desire to impose tariffs will hurt the Eurozone's economy more than the UK's, which offers GBP/EUR a path higher.

Pound Sterling's recovery follows the slump that followed the UK's budget, where investors proved nervous about aggressive spending, borrowing and taxation announcements.

The UK's debt burden will be higher than expected as the government looks to boost spending significantly.

That spending will provide a sugar rush of growth to the economy next year and raise inflation by more than the Bank of England had previously anticipated, requiring the Bank of England to strike a cautious approach to cutting interest rates.

Above: GBP/EUR at daily intervals.

"The upward revision to the CPI profile allied to an extension of relative policy patience (the BoE remains mindful of relatively tight labour market conditions, despite recent loosening) supports our narrative of the BoE taking longer to get to neutral," says Jeremy Stretch, Chief International Strategist at CIBC Capital Markets.

CIBC expects the ECB and Bank of England's monetary policies will continue to diverge. "There is increasing pressure on the ECB to act faster as Germany faces a second year of contraction for the first time since 2002/03," he explains.

Stretch says a combination of the recent UK fiscal boost allied to eurozone macro headwinds supports EUR/GBP downside. "A breach of the 2024 low at 0.8295 will open the way for a test towards 0.8250."

This would equate to a move to 1.2121 in GBP/EUR terms.