Pound-Euro Scales Highs Ahead of ECB

ECB President Christine Lagarde. Image: Andreas Reeg/ECB.

Pound Sterling closed at its highest level against the Euro in 21 months on Wednesday but risks a setback in the form of today's European Central Bank decision.

The Pound to Euro closed at 1.1759, the highest daily finish since August 2022, amidst a recovery in global equity markets that tends to help the risk-sensitive Pound.

But, Euro exchange rates will be front and centre on Thursday when the European Central Bank (ECB) cuts interest rates and gives guidance as to when a follow-up cut could come.

With the June cut expected for weeks now, the timing of the next cut will be the focus for forward-looking currency markets. Matthew Ryan, Head of Market Strategy at Ebury, says the Euro could rally "despite the expected 25bp ECB cut."

"We think that Lagarde will make a conscious effort to remain as vague as possible on future cuts," he explains.

Markets show low odds of the ECB delivering a follow-up rate cut in July, noting that a recent pickup in inflation will ensure the ECB's Governing Council adopts a cautious approach to the next steps.

The fear is that cutting rates too soon and by too much could inflame inflationary spirits.

Ryan says ECB President Christine Lagarde may flag disquiet over inflation while saying that the Eurozone's economy has performed better since the last meeting.

"This could be perceived as an indication that the ECB will be in no real rush to ease policy again, which may provide the impetus for another rally in the euro," he adds.

Above: GBP/EUR commands a constructive setup heading into the ECB decision. Track GBP/EUR with your own custom rate alerts. Set Up Here 

"She will not give any major hints on the further interest rate trend, but will instead refer to the future data situation," says Antje Praefcke, FX Analyst at Commerzbank. "This could disappoint some market participants who are expecting hints of further interest rate cuts and give the euro a helping hand."

The Pound-Euro exchange rate retains a positive technical setup, having hit 21-month highs last week. However, this setup risks deterioration in the event of clear signals that the ECB is hesitant to cut interest rates further in the coming months.

"A follow-up cut in July is priced at just 1/10 so anything that hints at this would be euro-negative... but unlikely. Markets assume another cut by October, and I think the ECB will give a signal of sorts towards this kind of date," says Neil Wilson, analyst at Finalto.

Nick Kounis, an economist at ABN AMRO, says recent firm data on services inflation have probably convinced officials to wait and see the timing of further reductions. The chances of an immediate further reduction in July have come down.

But Kounis says markets are underappreciating the scale of rate cuts to come, which, if correct, could result in a weaker Euro.

"We think a clear easing bias will remain, with the Council signalling that the timing and extent of rate cuts will de data dependent. The easing bias will be reinforced by the updated staff macroeconomic projections," he says.

ABN Amro expects the ECB's forecasts to be broadly unchanged relative to the March ones. "This should show inflation modestly undershooting the ECB’s inflation target over the medium term, hence signalling the need for an easing cycle," says Kounis. "We see considerable room for interest rates to come down over the next year."

Markets are pricing in only one further rate reduction this year after the June cut and roughly a 50% chance of a second.

"This seems to us to be underestimating the potential for further reductions this year," says Kounis.