The Euro is Today's Best Perfomer as Exchange Rate Markets Increase Bets on ECB Tapering

• Pound to Euro Exchange Rate Reference: 1.1656, down 0.80%
• Euro to Dollar Exchange Rate Reference: 1.1082, Up 0.98%

The Euro retains a commanding position heading into the mid-week session and is now the month-to date best performer in the G10 complex, a sign of how much momentum is building behind the currency's rally.

The gains come as investors expect the European Central Bank (ECB) to soon announce changes to policy that will ultimately benefit the Euro.

"The higher EUR seems to be a cause of an anticipation of a shift in the ECB monetary stance," says Petr Krpata at ING in London.

Markets appear to be betting heavily that with the French election behind us and a growing Eurozone economy the time for a sea-change in policy at the ECB beckons.

Asset purchases - the ECB's official term for its monet-printing programme - is currently maintained at a new monthly pace of €60 billion and is intended to run until the end of December 2017.

Analysts are expecting the central bank to hint at its June meeting that stimulus will slowly be withdrawn over coming months. An interest rate rise could even be on the cards for late-2017 / early-2018.

This withdrawal is referred to as 'tapering' in financial circles.

A look at the markets shows the Euro is up by an equal amount against the Pound and Dollar.

This is important as it suggests that the Pound to Euro exchange rate's weakness is NOT because of today's inflation release, as suggested by many of the tabloids who have recently entered the currency reporting space.

The Euro to Pound rate trades at 0.8573, up 0.73%. The Pound to Euro exchange rate trades at 1.1665 meaning international payments now fall in the region of 1.1247 and 1.1550.

The Euro to Dollar rate at 1.1053, up 0.71%. International payment rates now lie between 1.0678 and 1.0965.

"The market focused the convergence trade in G10FX, which we think is still in its infancy but we look for EURUSD to close out the year around 1.12," says Richard Kelly, Head of Global Strategy at TD Securities. "This backdrop also leaves us buyers on dips of EUR/GBP."

The convergence trade mentioned by Kelly refers to a move by traders to focus on the differences in interest rate policies between different countries and suggests markets are pricing in the ECB playing catch-up with the US Fed.

The ECB has good reason to start considering a future of higher interest rates.

The Eurozone economy expanded by 0.5%q/q in Q1, matching the Q4 outturn.

"Strong levels of business sentiment at the start of Q2 suggest that the positive momentum is likely to continue. Moreover, political risks have subsided for now, with ‘populist’ support increasing, but failing to break through, in the Dutch general election and the French presidential election." says Hann-Ju Ho, an economist with Lloyds Bank in London.

The ECB’s assessment of Eurozone economic growth prospects has brightened.

At the last meeting in April, President Draghi described the recovery as being “increasingly solid” and that downside risks have “further diminished”.

The ECB has acknowledged that deflation risks have largely disappeared, but it is not yet convinced that inflation will be sustained at its goal of close to, but below, 2% without continued monetary policy stimulus.

"We anticipate the ECB will make further changes to its statement at the next meeting on 8th June, when it is expected to upgrade its growth assessment towards a more balanced outlook," says Ho.

However, Lloyds believe it is still too early to expect a notable shift in sentiment which, if correct, draws questions as to whether foreign exchange markets are getting ahead of themselves.

Lloyds expect the ECB to continue with its current pace of asset purchases until the end of the year. Our forecast is for it to communicate a reduction in asset purchases in 2018 at the September meeting, potentially to an average monthly pace of €40bn.