Pound-Euro Risks Skewed to the Upside for Now: MUFG

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According to an investment bank analyst we follow, Pound Sterling can extend a recent advance against the Euro.

Derek Halpenny, Head of Research for Global Markets at MUFG, says the British Pound will find itself particularly well supported against the Euro, given his expectations that the Bank of England will cut interest rates after the European Central Bank.

The call is a reminder that the timing and scale of central bank interest rate cuts in 2024 is a fundamental driver of the exchange rate landscape.

"The BoE are likely to remain much more concerned over domestically generated inflation than in either the U.S. or the euro-zone," says Halpenny.

The market is now priced for the BoE to cut by 25bps in August next year, which is later than the ECB and the Fed and has offered Sterling some relative support against the two currencies. Owing to this, the Pound to Euro exchange rate has risen for nine of the past ten trading days, with a 0.74% surge coming last Friday alone.

The pair peaked at 1.1691 on Monday before retreating amidst overbought conditions. We predicted this development was highly likely when we wrote our week-ahead forecast for the pair over the weekend.

But Halpenny says the outlook remains constructive for Pound Sterling, citing the relatively 'hawkish' stance of Bank of England policymakers who are keen to avoid any undue speculation about the prospect of interest rate cuts.

Most recently, Monetary Policy Committee (MPC) member Catherine Mann stated that services inflation would "have to go from 6%-plus down to 3%" to get overall inflation back under control, suggesting a hard slog ahead on the inflation front.

But the rapid rise in the Pound-Euro also has the Euro side of the equation to thank: the single currency came under considerable pressure over recent days as markets bring forward expectations for rate cuts at the European Central Bank (ECB).

Above: GBPEUR's rapid rally left it overbought according to the Relative Strength Index (lower panel). Track GBPEUR with your own custom rate alerts. Set Up Here

Underscoring this development was the below-consensus Eurozone inflation readings for November, released last week, which suggested inflation is firmly on course to fall to the ECB's 2.0% target.

"The shift in thinking on the ECB given the recent evidence of faster declines in inflation does leave EUR/GBP open to further falls as a divergence in inflation and therefore policy expectations widens further," says Halpenny.

"EUR/GBP has dropped through its 50-day, 100-day and 200-day moving averages in the last five trading days and risks are skewed to the downside for now," he adds.

Analyst George Vessey at Convera - the international payments firm - says the deviation in expectations for Eurozone and Bank of England rate cuts is clearly seen on global bond markets, where the difference between UK and German two-year bonds has widened.

"The rise in 2-year UK-German yield spreads after cooling Eurozone inflation helped support the uplift," he says, referencing the rise in Pound-Euro.

"We see room for further upside given the pair has broken out of its descending trend channel and is above all of its key long-term daily and weekly moving averages," he adds.