GBP/EUR Week Ahead Forecast: Struggling as Wage Data and BoE Loom

• -GBP/EUR supported at 1.1650 with BoE, jobs data ahead
• -Could struggle for traction without hawkish BoE surprise 
• -Recovery possible if BoE lifts rates further than expected
• -UK employment, wage data eyed ahead of BoE decision 

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The Pound to Euro exchange rate was little changed following a volatile week last Friday and could continue to struggle for traction in the days ahead unless the Bank of England (BoE) surprises the market by adopting a more ‘hawkish’ interest rate stance in Thursday’s monetary policy decision.

Sterling made several attempts at lifting meaningfully above 1.17 against the Euro last week but was unable to sustain upward momentum even as the single currency struggled to capitalise on Thursday's landmark European Central Bank (ECB) policy change.

The Pound to Euro rate would have better luck this week, however, if the BoE surprises the market by lifting Bank Rate in a larger than expected increment or if it otherwise adopts a more hawkish stance that gives rise to the possibility of larger increases in the months ahead. 

But economists widely expect Bank Rate to rise from 1% to only 1.25% and the BoE itself has spent recent months pushing back against hawkish market expectations for its interest rate to rise to 2% or more by year-end. 

“At more than twice the BoE’s official target of 2%, sky-high inflation expectations present at least as big a problem for policymakers as the ongoing inflation surge,” says Kallum Pickering, an economist at Berenberg. 

Above: Pound to Euro rate shown at daily intervals with selected moving-averages and Fibonacci retracements of April 2022 decline indicating possible short-term areas of technical resistance for Sterling. Click image for closer inspection.

The BoE’s Inflation Attitudes Survey released on Friday is one reason why risks around this week’s decision may be tilted toward the upside somewhat after it showed expectations for inflation in the year ahead reaching a new record of 4.6% among the public in May.

“This implies a degree of public belief that inflation will move lower relative to current rates. But the series has not recorded a monthly decline in inflation expectations by this measure since January,” says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

UK inflation reached 9% in April and concern about the outlook for it would potentially grow further at the BoE if this Tuesday’s employment data confirms a continuation of the high single digit percentage increases in wages and salaries seen back in March. 

“The labour market remains uncomfortably tight – in spite of the recent growth slowdown. While pay settlements have yet to reach Bank Agents' expectations, one-off payments to retain workers have risen by more than we anticipated,” says Sanjay Raja, an economist at Deutsche Bank.

Economists are looking for wage packets to have grown by more than 7% in the three months to the end of April, which would further narrow the gap between pay growth and inflation in an outcome that may be interpreted by the BoE as an argument for a faster pace of rate rises. 

Above: Pound to Euro rate shown at weekly intervals with Fibonacci retracements of 2020 recovery indicating possible short-term areas of technical support for Sterling. Click image for closer inspection.

“Solid labour market performance, especially in terms of low unemployment and elevated vacancies, will support the case for some MPC members to vote for a 50bp hike next week,” says Abbas Khan, an economist at Barclays. 

Khan looks for Bank Rate to rise by only 0.25% this week but acknowledges that cost-of-living support announced by HM Treasury in May could prompt a change in the pace at which the BoE lifts Bank Rate further down the line.

Others disagree, however, and some see risks of a disappointment for markets on Thursday that could lead to weakness in Sterling.

“We doubt that pressure on the BoE to raise rates by 50bp has increased after the government’s fiscal spending on energy bills, as the cost-of-living crisis continues to deteriorate with record high petrol prices in the UK over the past week,” says Jordan Rochester, a strategist at Nomura. 

“With 33bp priced for the meeting we expect short-term GBP weakness after a 25bp rate hike vote. However, it’s the August meeting where the pain could be felt more, with cumulatively 73bp priced in,” Rochester also warned on Friday.