Pound on the Charge Against Euro Following BoE Minutes

The pound to euro exchange rate has recovered in mid-week trade on the back of hawkish Bank of England MPC minutes.

The minutes from the July meeting - which kept interest rates unchanged - showed members of the committee are concerned about the prospects of higher inflation in coming months.

Higher inflation would have to be fought using higher interest rates which then in turn feed into higher GBP exchange rates.

"The improvement in wages could easily boost inflationary pressures and leave the Bank of England short of time before taking back the full control on consumer prices," says Ipek Ozkardeskaya at London Capital Group.

Ozkardeskaya is positive on sterling's outlook following the relese:

"The clear divergence from the leading G10 policy makers, particularly from the ECB, BoJ and commodity sensitive BoC, RBA and RBNZ, should keep the appetite in pound tight enough for further appreciation. On trade weighted basis, British pound recovered two thirds since it fell from its 2007 pick, there is 30% more to go before reaching the pre-crisis levels.”

Pound Recovers

The overbought nature of the pound to euro exchange rate (GBPEUR) following the recent impressive rally that allowed GBP-EUR to press 1.44 has ensured that many major currency players have taken their money out of the pair to take advantage of any profit made over recent days.

This has seen the GBP-EUR slump from a recent best above 1.44 back towards 1.42.

Average bank offers for international payments have slipped below 1.39 while independents are closer to the market at 1.405.

"Profit-taking also caught up with the higher flying U.K. pound on caution ahead of Wednesday’s release of important minutes from the previous Bank of England (BOE) meeting. Sterling eased toward the middle of its range over the past month, an area nearly 4 cents below the seven-month peak the pound had notched in mid-June," says Joe Manimbo, analyst at Western Union.

Why has the Euro Suddenly Strengthened?

Sovereign bond yields are the MOST important driver of exchange rates at the present time. Higher bond yields = a higher currency.

For the euro we note the German yield curve has steepened with yields up to 3.9 bps higher - the euro has risen in response.

Driving German yields higher will be the improvement in Greece:

Rating agency Standard & Poor’s raised yesterday evening the credit rating of Greece by two notches to CCC+, saying the European bailout reduced the chances of the country defaulting on its massive debt during the next year. The outlook was also upgraded from negative to stable.

Data Should Favour the Pound

Despite current losses, the bigger picture continues to undoubtedly favour sterling.

“Over the last five sessions the GBP has outperformed all the majors, bar the USD. This is unsurprising as the US is of the course the only other major where monetary tightening is currently on the agenda. We would continue to argue that an improving underlying fundamental environment favours broad-based GBP resilience,” notes Jeremy Stretch, an analyst with CIBC Markets.

June fiscal deficit came better than expected as an improvement was driven by personal and corporate tax revenues. The smallest fiscal shortfall in seven years comes as government incomes advanced 4.4%, compared to spending which increased by 2.9%.

“Key to further GBP impetus will be the strength of the retail sector - data due on Thursday, after the publication of July MPC minutes tomorrow. For now the market continues to expect BoE unanimity, August could prove more of a challenge as the decision comes in conjunction with revised macro forecasts,” says Stretch.

Markets are looking for UK retail sales to have increased by 0.3% over a month-on-month basis, an improvement on the previous reading of 0.2%.

It goes without saying, any disappointments here could lead to a further decline in the pound euro exchange rate.

With regards to the BoE Minutes, any signs of a return of MPC dissent, allied to the ongoing unwind of excessive GBP shorts, favour ongoing TWI upside.

For the pound / euro exchange rate this points towards fresh eight-year highs at 1.4503 suggest CIBC.