Euro "Better Protected" Against Pound and Dollar

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Euro exchange rates look better protected against further downside as Eurozone inflation limits scope for ECB rate cuts.

Eurozone inflation rose to 2.4% in December from 2.2% and core inflation remained stuck at 2.7% for a fourth consecutive month.

The developments dimmed the odds of an accelerated pace to European Central Bank rate cuts.

"The battered euro's downside is finally looking better protected. We feel a lot of negatives have been priced in by now," says a note from KBC Bank. "The bar for euro area money markets to price in more ECB easing (100 bps this year) is rising."

Firming market expectations are reflected in the currency, with the Euro to Pound Sterling exchange rate (EUR/GBP) solidifying at levels around 0.8290, while the Euro to Dollar rate (EUR/USD) is supported above the 1.0260 support line.

Sam Hill, Head of Market Analysis at Lloyds Bank, says the ECB looks set to ease at consecutive meetings over the first quarter at the minimum. "It does mean that policy rates will remain restrictive for longer," he explains.

Higher-for-longer is typically supportive of a currency.

Had Eurozone inflation undershot expectations and raised odds of an accelerated pace to rate cuts, the Euro would have come under pressure.

However, the setup is one in which the Euro now looks better insulated against weakness, particularly against the British Pound. Here, the risks of an accelerated pace in the Bank of England's rate cutting strategy could grow if the economy continues to slow.

"The BoE’s hawkish cut in November was followed by a dovish hold in December where one of the status quo voters is close in switching sides. We think current market pricing of only two rate cuts in 2025 is too conservative. That’s making both UK yields at the front end and sterling vulnerable for downside eco data misses. EUR/GBP’s bottom around 0.823 looks a bit better protected," says KBC.

Above: EUR/GBP (top) and EUR/USD at daily intervals.

GBP/EUR investment bank consensus forecast for 2025. See the median, mean, highest and lowest point targets, giving a highly accurate forecasting resource. Request it Now.

Downside risks for the Euro involve Eurozone inflation falling faster than expected in the first quarter of 2025, which is possible owing to favourable base effects.

"Our forecast is that the underlying inflation rate will slow at the start of the year, when the strong start in 2024 falls out of the comparative figures, so even if today's numbers matters to the ECB, their latest forecast will only be put to the test when we get the January and February numbers," says Marcus Widén, an analyst at SEB.

Analysts at Capital Economics point out that the high level of services inflation - which is underpinning core inflation - is partly due to temporary effects that should fade this year.

"Meanwhile, the labour market has loosened, wage growth is slowing and the growth outlook is weak," says Jack Allen-Reynolds, Deputy Chief Euro-zone Economist at Capital Economics.