GBP/EUR Probes sub-1.13, Wunsch Signals Higher ECB Interest Rates

Above: File image of Pierre Wunsch, Governor of the National Bank of Belgium. Image: Pound Sterling Live and NBB.

Pound Sterling is expected by analysts to remain under near-term pressure against the Euro as foreign exchange markets continue to expect the European Central Bank (ECB) to outpace the Bank of England in raising interest rates over the next few months.

Demand for the Eurozone's single currency was boosted following comments from a key member of the ECB, prompting the Pound to Euro exchange rate (GBP/EUR) to test levels below 1.13 again. Declines to 1.1270 and then 1.12 are now visible in the chart.

National Bank of Belgium's Pierre Wunch said the market was underestimating the scale of incoming interest rate hikes as inflation would unlikely fall back to acceptable levels unless wage growth retreated.

Wunch, who sits on the ECB's interest rate-setting Governing Council, said in an interview with the FT that, "we are waiting for wage growth and core inflation to go down, along with headline inflation, before we can arrive at the point where we can pause."

Wunch's specific focus on wage growth suggests the ECB is not yet close to ending its rate hiking cycle which underscores the Euro exchange rate's outperformance over recent weeks.

"It feels as if the euro is the market’s preferred currency. First of all, the ECB seems simply perceived as more restrictive at present thanks to the many comments from hawks on the board," says Antje Praefcke, FX Analyst at Commerzbank.

ECB president Christine Lagarde said in March higher wages were one of the factors that "could drive inflation higher," when announcing the ECB's decision to raise its deposit rate from 2.5% to 3%.

Wages in the eurozone increased at a record pace of 5.7% between the final quarter of 2022 and a year earlier as companies increase pay packets to retain and attract staff.

"I would not be surprised if we had to go to 4% at some point," said Wunsch.

"The ECB's Wunsch indicating that the market is 'underestimating' the Eurozone rate peak. He also said he would not be surprised if the depo rate goes to 4% which compares with a market assumption of around 3.5% currently," says Brad Bechtel, Global Head of FX at Jefferies LLC.

Although the Federal Reserve and Bank of England are likely to raise rates to a higher terminal level the market is reacting to the number of rates each is yet to still deliver.

On this count, the Euro is looking preferred to the Dollar and Sterling.

GBP/EUR dipped below 1.13 amidst ongoing demand for the Euro and is expected to remain under pressure as long as ECB Governing Council members continue to advocate for further rate hikes.

Jeremy Stretch, a strategist at CIBC Capital Markets, says he maintains a bias for further gains by the Euro against Pound Sterling owing to the ECB's stance on interest rates.

"We continue to favour greater ECB activism, opening the way for a test of the recent high at 0.8872," says Stretch. EUR/GBP at 0.8872 equates to GBP/EUR at 1.1270.

Above: GBP/EUR is under pressure again. (Stay on top of this market by setting up an FX alert).

Beyond 1.1270 lies the mid-February and early-March lows at 1.12 which saw support emerge. But 2023's low at 1.1137 would come into view should this level be breached on a closing basis.

The Euro has been one of the better-performing currencies of 2023 as investors react to falling gas prices and a run of data releases that beat expectations.

The improved economic outlook and strong labour markets have driven up wages which have acted to underpin inflation in the bloc above the ECB's 2.0% target.

Interest rate hikes at the ECB have in turn pushed up regional bond yields and attracted inflows of foreign investor capital looking for positive returns in corporate and sovereign bonds.

These fixed income inflows contributed to the Eurozone's Balance of Payments turning positive again in the first quarter.

"We first highlighted how elements of the Eurozone's external flow backdrop were turning more positive back in December 2022, and followed up on further improvements earlier this year," says Dominic Bunning, FX strategist at HSBC.

Bunning is positive on the Euro's outlook as the region's economic picture is set to improve further and widen the current account surplus, a fundamental source of support for Euro valuations.