Pound Euro Exchange Rate Recovers as European Central Bank Gets Active

The uptrend in the GBP/EUR pairing lost momentum this October with an upward trajectory being halted as expectations for a Bank of England interest rate are moved back into mid-2015.

Indeed, the pound to euro exchange rate appeared to be on course to deliver a test of the psychologically important 1.24 conversion level.

It would seem though that perspective was returned to the markets on Thursday the 16th of October when the GBP/EUR surged higher in response to growing concerns about the Eurozone economy; sterling recovered and has creeped higher.

The longer-term picture facing the GBP-EUR looks as follows:

• Our last quote on the pound to euro rate is 0.23 pct lower on a day-to-day basis at 1.2602.
• The euro to pound rate (EUR/GBP) is at 0.7932.

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European Central Bank Stamps EUR Lower

A fresh boost was afforded to GBP/EUR when the European Central Bank announced that it was taking a proactive approach to halting the Eurozone economy's slump by entering the secondary corporate bond market.

The ECB may decide on the matter as soon as December with a view to begin purchases early next year Reuters reports.

The news will remind markets that there is potentially a great amount of EUR-negative news, and action, due to come out of the ECB in coming weeks.

Risks for the GBP in the Week Ahead

The Bank of England (BoE) minutes from the October policy meeting are due for release mid-week.

If it is indicated that the Bank is set to place a longer-than-expected halt to its rate raising regime markets could well sell the pound once more.

Barclays analyst Hamish Pepper says they are still bullish on the pound's prospects ahead of the minutes release:

"There is a risk that the market discounts the value of the minutes given that they relate to the 9 October meeting and will therefore not incorporate the recent large drop in UK CPI inflation as well as the deterioration in euro area growth prospects.

"In response to these recent developments, interest rate markets have aggressively repriced BoE base rate expectations over recent weeks and now expect barely +25bp next year, and not even +50bp in 2016.

"As such, we have pushed back our forecast for the first BoE rate hike from November to February 2015 but remain well above market expectations, consistent with our view of GBP outperformance vs the EUR."

Pressures on Euro Rise

The outlook for the euro is however more uncertain owing to signs that the Eurozone economy is slowing down again.

Recent data has focused attention on weakening German fundamentals which may lead the Bundesbank to acquiesce to more aggressive ECB action.

Many in the markets are preparing for the possibility of full-scale quantitative easing being introduced by the ECB.

Any such move will surely sent the euro exchange rate lower.

Further signs of stagnation should be enough to sway German policymakers to finally accept the purchase of sovereign bonds by the ECB.

"Increasingly likely action from President Draghi is a reason why we remain euro bears," say CIBC World Markets.

Morgan Stanley: Structural Decline Expected. Bearish.

Joining the euro-negative camp are Morgan Stanley who say:

"We remain bearish on EUR, especially against USD and JPY, since inflation expectations continue to fall, economic data from Germany are coming in weaker and the ECB continues to remain accommodative, beginning asset purchases in the coming weeks.

"The 5y5y inflation expectations are now at 1.77% and core bond yields continue to fall. Record ETF outflows have been seen out of Europe in the past week, suggesting that there could be further EUR weakness."

Germany Could Undermine the Euro

Credit Agricole tell us that German data will be key to the near-term outlook for the euro:

"The engine of the German economy is down and is proving hard to rev up again.

"Figures for industrial orders clearly showed the trend with an investment cycle close to finish, and both foreign and domestic demand very weak.

"The flash PMI for the manufacturing sector is expected to decrease from 49.9 in September to 49.6 in October.

"Flash PMI services will likely drop to 55.3 in October from 55.7 in the previous month. All in all, the flash composite is expected to decrease to 53.7 (from 54.1 in the previous month), reflecting the slack in the economy.

"After a 1 point decrease in September, the French composite PMI is expected to slightly increase to 49.1 in October (after 48.4 in September). We expect the flash estimate of the manufacturing PMI to show a deterioration from 48.8 to 48.0, while we see the flash services PMI up by 1pt from 48.4 to 49.4.

"In the manufacturing sector, business confidence is likely capped by internal factors (and notably the sluggish growth), but also external developments (geopolitical instability in the Middle East notably).

"Conversely, we believe that the current level of the services gauge is too low and is set to increase."