GBP/EUR Rate Looks Heavy Heading Into Central Bank Doubleheader

Image © Pound Sterling Live

The Pound to Euro exchange rate could be headed back towards 1.15 if the Bank of England struggles to contain a rise in market expectations for interest rate cuts in 2024, but the European Central Bank succeeds.

Pound Sterling has come under pressure ahead of today's European central banking doubleheader, courtesy of two softer-than-expected UK data releases that prompted markets to 'price in' over 100 basis points of UK rate cuts in 2024.

Following Tuesday's wage report, money market pricing shows investors are now assigning roughly a 50% implied probability of a first 25 basis point rate cut in May.

This means a June cut is now fully priced, whereas the first cut was only expected in August as of Monday.

Deutsche Bank says that with wage growth finally showing convincing signs of normalisation, the bar has been raised for the Bank of England to explicitly push back on market pricing of rate cuts for next year.

Yet the market still expects more by way of rate cuts from the European Central Bank in 2024, to the tune of 150 basis points, expectations which weighed on the Euro during much of December.

"Sterling has benefited in the last few weeks, especially versus the euro, as ECB rate cut speculation ramps up," says Jamie Dutta, Market Analyst at online broker Vantage.

But for the Euro, it is hard to see how the market can build on these expectations from here, removing a potential drag on the Euro. Given the rich pricing for cuts, the ECB could also find it easier to successfully push back against the market than the Bank of England.

Above: "EURGBP is on course for its smallest annual range since 2006" - Deutsche Bank. Track GBP with your own custom rate alerts. Set Up Here.

"The euro has now priced in a large degree of ostensibly bearish information," says Joe Tuckey, Head of FX Analysis at Argentex Group PLC. This creates a downside risk for the Pound-Euro rate.

Ahead of the dual central bank meetings, Deutsche Bank says Pound Sterling "screens a little rich for the first time all year, against both real (5y) and front-end relative rates".

"As it stands a simple average of the two rates metrics pins EURGBP close to 0.87, right in the middle of this year's narrow range," says Shreyas Gopal, strategist at Deutsche Bank.

This implies a recalibration in the Pound-Euro exchange rate to fairer values around 1.15.

Above: The Euro is looking undervalued relative to the Pound, says Deutsche Bank.

"Any hints from Bailey and co of policy loosening will see selling in the pound. However, it is much more likely that the language will be around the restrictive stance of the current policy setting needing to remain so for an extended period," says Vantage's Dutta.

Matthew Ryan, Head of Market Strategy at Ebury, says the vote composition to keep interest rates at 5.25% will send an important signal to foreign exchange markets.

"We think that the vote will remain unchanged this time around, with external members Green, Haskel, and Mann to once again vote in favour of an immediate hike, which should reinforce the bank’s ‘higher for longer’ attitude to rates. There is a possibility that dove Swati Dhingra votes for an immediate cut, although this would perhaps be counterproductive to the bank's goal of dampening expectations for lower rates," he says.

Ebury thinks markets are getting carried away with the extent of policy easing required in 2024.

"A 6-3 vote on rates, combined with rhetoric that reiterates no cuts for the foreseeable future, should be bullish for the pound given current market pricing," says Ryan.

On the other hand, should the statement express greater optimism on inflation, and one or more MPC members shift their vote in a dovish direction, Ryan warns we could see some modest downside in GBP towards the end of the week.