Pound-Euro Week Ahead Forecast: Glimpsing 1.18 On Any ‘Hawkish’ Tinge in BoE's Voice

- GBP/EUR supported at 1.1617 & 1.1550 further down
- May break 1.17, test 1.18 if BoE worries over inflation
- PMI surveys eyed before BoE, in a quiet week for EUR

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• GBP/EUR reference rates at publication:
• Spot: 1.1633
• Bank transfers (indicative guide): 1.1326-1.1407
• Money transfer specialist rates (indicative): 1.1550-1.1575
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The Pound-to-Euro exchange rate enters a pivotal week having held comfortably above 1.16 even after a heavy fall on Friday, and could have scope to retest its 2021 highs around 1.18 over the coming days if there's any 'hawkish' tinge to the latest Bank of England (BoE) policy update on Thursday.

Pound Sterling ended the week in the red against many currencies amid risk aversion in broader global financial markets as well as what may have been upset or otherwise caution over the UK’s retail sales report for the month of May.

Retail sales fell -1.4% last month when the consensus among economists was for around a 1.5% increase, although the decline and disappointment for observers and market participants alike came only after an almost-unheard of 9.2% increase in the prior month and so mostly reflected statistical base effects.

More important among last week’s data, and certainly as it relates to price action over the coming days, were inflation figures for the month of May which showed both the main consumer price index and the adjusted measure that overlooks energy prices each rising to or above the 2% target of the BoE.

What-if-anything the BoE’s policymakers read into this could be informative of the tone adopted by the BoE and Governor Andrew Bailey in the latest monetary policy update due out on Thursday at 12:00 London time, which is the highlight of the week for Sterling.

“The BoE is not aiming to overshoot the target, like the Fed, or to run an outcomes-based policy. Policy is tied to forecasts that will inevitably shift with the data. And growth and inflation are outperforming BoE forecasts. We expect that to continue,” says Robert Wood, an economist at BofA Global Research.

“The outperformance already has caused rate setters to reassess their views. One of the most dovish BoE rate setters, Gertjan Vlieghe, expects a rate hike in 2H 2022 if the data follow the BoE's central forecast,” Wood adds.

Above: Pound-to-Euro rate at daily intervals with 55, 100 & 200 day moving-averages and Fibonacci retracements of April recovery.

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The BoE said in May that it wouldn’t hesitate to take action - likely by lifting Bank Rate from its current 0.10% threshold - in the event that the nascent surge of inflation back to the 2% target proves to be more than just a temporary post-pandemic phenomenon which means there’s certainly the possibility of there being a ‘hawkish’ tinge in its words about the outlook this week.

“Although retail sales in May gave back some of their earlier gains, a solid rise in employment suggested the recovery is still in good fettle. Meanwhile, a jump in inflation the same month mainly reflected pandemic-related factors,” says Martin Beck, lead UK economist at Oxford Economics.

“A delay to the final stage of easing domestic Covid restrictions should prove only a small bump on the road to economic recovery. We still expect GDP to regain pre-pandemic levels before the end of this year,” Beck adds.

Despite the above it is however anybody’s guess what the outcome of this week’s meeting will mean for Pound Sterling, and not least because Governor Bailey warned following the BoE’s last meeting of downside risks to its latest set of economic forecasts, which were announced in May and envisage a 2021 GDP growth rate that would be the strongest seen in the UK since shortly after the second world war.

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One of the various reasons there are downside risks to those forecasts is uncertainty over the trajectory of the coronavirus and the extent to which any renewed increases in infections could lead to a return of economy-encumbering restrictions on business activities and social contact: It may matter in this regard that since then the government has prolonged the life of its last remaining restrictions, which could potentially be viewed by the BoE as a tentative crystallization of those downside risks.

Nonetheless and after entering the new week around 1.1630 the Pound-to-Euro exchange rate will benefit from a cluster of nearby support levels as between 1.1550 and 1.1600 there are two major moving-averages as well as a Fibonacci retracement level that could break Sterling’s fall in any bouts of weakness: When translated into EUR/GBP terms, this implies tough resistance between 0.8620 and 0.8658.

“Price action has all the hallmarks of a short, sharp position adjustment – suggesting the bulk of the correction may have occurred. Yet we feel Fed speak could see EUR/USD correct a little further lower this week,” says Chris Turner, global head of markets and regional head of research at ING.

On the upside of Sterling’s entry point into the new week much depends on what the U.S. Dollar does over the coming days, as this has a notably indirect influence on the Pound-to-Euro exchange rate, which would trade as high as 1.1800 following the BoE’s decision if Thursday’s update happened to prove supportive of the Pound while at the same time the Dollar continued to keep other currencies under pressure due to the impact the latter would likely have on EUR/USD.

Above: Pound-to-Euro rate at weekly intervals with GBP/USD and EUR/USD.

The Euro-Dollar rate is a substantial direct influence on GBP/EUR and so if the former was unable to get meaningfully above its Friday closing level of 1.1850 this week, then the Pound-to-Euro exchange rate could find itself lifted at least briefly as far as 1.18 even if the main Sterling exchange rate GBP/USD was to retrace only a portion of last week’s Federal Reserve (Fed) inspired decline in response to the BoE this Thursday.

The Pound-Dollar rate declined from around 1.41 last Monday to around 1.38 by Friday’s close after the Fed surprised the market by adapting its own monetary policy guidance in a ‘hawkish’ direction and would still retain a downside corrective trajectory even if GBP/USD was to retrace a full 50% of the June month’s decline from 1.4240: This, while not much of a move in GBP/USD terms, would provide a powerful lift to GBP/EUR if it was to be combined with a lethargic performance from EUR/USD.

"Post Fed, we’re adjusting our USD risk here and switching into short EUR/GBP to express the bullish GBP view into the BOE next week," says Jordan Rochester, a strategist at Nomura. "We expect GBP to outperform but look to reduce our USD risk and take profit on our GBP/USD longs. We shift into short EUR/GBP in cash instead (entry: 0.8550; target 0.83, stop 0.8750)."

There’s little by way of economic data in the calendar to impact Europe’s single currency this week while ahead of Thursday’s update from the Bank of England there’s only the latest IHS Markit PMI surveys of the UK’s manufacturing and services sectors to occupy Sterling: These survey indices have recently reached record highs and whether they remain ascendant or instead correct lower could be an important signal of the trajectory for the UK’s economy in the coming months.