GBP/EUR: One-month Strategy

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The Pound to Euro exchange rate (GBPEUR) looks to test the 1.17 level over the coming hours and should remain supported over the coming month - data allowing - with further tests of the 2023 high probable if the May-July trend of appreciation remains intact.

Pound Sterling is supported by elevated expectations for more Bank of England rate hikes relative to those likely to come from the European Central Bank, ensuring UK bond yields remain higher than those of the Eurozone.

"This is a yield starved environment for investors," says Stephen Gallo, Global FX Strategist at BMO Capital Markets.

He explains that above average issuance of bonds by the government's Debt Management Office - to fund a significant public debt burden that recently reached 100% of GDP - is being easily absorbed.

"Higher relative UK rates drag GBP along for the ride," adds Gallo. If we discount the late-June highs, current levels in Pound-Euro were last seen in December.

Above: UK two-year bond yields (blue) and German two-year bond yields.

Those with international payments involving either side of the Pound-Euro equation at some point in July should be aware that directional movement in this pair can sometimes be slow and consolidation in a 1.1550-1.1740 range is also a highly likely outcome of the coming days.

For a break to fresh 2023 highs, Pound Sterling would likely need some significant data surprises, with the July 11 labour market report and the July 19 inflation report being this month's most notable event risks.

Any disappointment in the data that results in a break below 1.1550 on a closing basis could potentially prove an interesting short-term development as this could signal the uptrend is in the process of breaking down.

Looking at the three-month view, multi-week the GBP is in a technical uptrend which suggests the upside is still favoured and a break to fresh 2023 highs is therefore possible.

Key downside risks include a deterioration in UK labour data and the Bank of England signalling in August that it is ready to slow down the pace of rate hikes should July inflation undershoot.

Above: GBP/EUR at daily intervals putting current levels into context.

Gallo is sceptical of the Pound's prospects over the coming six-nine month horizon, saying "the FX market is taking more of a one-dimensional approach to trading the British disease: instead of selling GBP in anticipation of an economic slowdown, it is buying GBP on the basis of interest rate differentials."

He looks for foreign exchange investors to unwind exposure to the Pound when the UK labour market and interest rates roll over.

Gallo's base case expectation is for the UK to experience a deeper recession than its peers as a consequence of the higher interest rates the Bank of England will deliver.

"Consequently, sterling interest rates and GBP fall by more than their peers," he says.