GBP/EUR Rate Hits New 41-Week High, Pushes Past 1.18 against Dollar

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Pound Sterling was broadly higher ahead of the weekend as it printed fresh highs against both the Euro and Dollar.

The Pound to Euro exchange rate rose to a new 41-week high at 1.1716 as the pair looked set to complete its ninth consecutive weekly advance.

The Pound was meanwhile on target to complete a third consecutive weekly advance against the Dollar as GBPUSD rose to 1.2848, its strongest rate of exchange since April 2022.

Gains come just days ahead of the UK's next inflation report and Bank of England interest rate decision which is expected to see another 25 basis point hike delivered. "The pound continues to profit from its inflation profile and market expectations of continued policy tightening by the Bank of England," says Boris Kovacevic, FX & Macro Strategist at Convera.

"Sterling appreciated sharply between yesterday and today, from GBP/USD 1.26 to 1.28, updating its highs against the dollar, both on the widespread correction of the U.S. currency and on consolidating market expectations for the BoE to hike rates again," says Asmarah Jamaleh, Economist at Intesa Sanpaolo.

The rally comes amidst elevated UK bond yields which are the result of investors betting the Bank of England will hike Bank Rate to a peak of 6.0% as it battles to fight inflation.

Such a development, if realised, would mean the Pound would benefit from one of the highest rates amongst developed economies, which would act as a magnet for foreign capital seeking higher returns, a trade known as the 'carry' trade.

"We are still in a good environment for carry and with volatility so low and some of the heavyweights of the central bank world behind us the market will likely continue to push the carry theme," says Brad Bechtel at Jefferies.

Above: GBPUSD (top) and GBPEUR at weekly intervals.

The Pound's rally does however come ahead of a key week for the UK economy in which CPI inflation data is released just a day before the Bank of England's next interest rates hike.

There are considerable downside risks for the Pound should the inflation figures undershoot expectations as this would prompt markets to reverse bets for the peak in Bank Rate at 6.0%.

Given how bloated Bank of England rate hike expectations are relative to where they were just a few months ago, there is a lot of air to be let out on this trade on any undershoot in the data.

"The British currency remains at risk of priced-in assumptions not playing out. It is still unknown how large the impact of tighter monetary policy on the real economy will be," says Kovacevic.

A spike lower in Sterling exchange rates therefore cannot be discounted over the coming days.

Yet, UK inflation remains elevated and even an undershoot on Wednesday won't be enough for the Bank of England to diverge from its policy of raising interest rates.

"We have BoE next week and they are dealing with an even harder situation than the ECB or Fed given their inflation numbers look far worse. Growth is holding up well despite the inflation figures and cost of living impact and the expectation is that the BoE will reluctantly keep hiking. GBP will remain better bid vs. USD, EUR and JPY for now," says Bechtel.