BoE Unlikely to Help Pound-to-Euro Rate Higher say Danske Bank

Above: Traders at Danske Bank © Danske Bank

The Pound-to-Euro exchange rate is said to be biased towards further weakness as the Bank of England is likely to fall short of market expectations this Thursday.

The view, is that of foreign exchange analysts at Danske Bank, who say the appetite for making a big signal shift at this Thursday's Bank of England policy meeting is low and will therefore prove disappointing for the Pound.

The Bank of England forms the highlight for Sterling this week with foreign exchange traders eager to establish where UK interest rates will go in 2018.

Markets are pricing in a 50-55% chance of an interest rate rise occurring in May, but the importance of Thursday's meeting lies in the signals that are delivered regarding future changes in the interest rate.

Should the expectations for a May interest rate rise increase then Sterling should go higher, should the Bank of England disappoint and expectations fall, Sterling will likely go lower.

Opinion on what the Bank offers at their super-Thursday event - which sees a monetary policy decision, minutes to that meeting and the inflation report all released - is currently divided.

We have reported already today that analysts at RBS believe a hawkish tilt will be delivered by the Bank, which should go some way in supporting their forecasts for a stronger Pound-to-Euro exchange rate over the next three months.

For further analyst views ahead of the event, we recommend readers view our analyst roundup here.

Sterling has received a steady bid from the market in recent months as traders reward the Bank’s November interest rate rise and markets express an increased optimism over the path of Brexit negotiations.

The improvement has helped lift the Pound-to-Dollar rate by around 4% while the Pound-to-Euro rate has traded towards the top of a multi-month range at 1.15 reflecting hopes that a stable economy, above-target inflation and signs that UK wages may finally be growing will mean the Bank of England pushes ahead with a second interest rate hike sooner rather than later.

However, nerves have increased ahead of Thursday's Bank of England policy meeting, and some the gains enjoyed by Sterling have since been pared as cautious traders express uncertainty as to which way the Bank will swing and external market conditions attract attention.

“EUR/GBP ended last week slightly higher driven by a sell-off in GBP/USD after strong US data,” says Jens Nærvig Pedersen, an analyst at Danske Bank.

The Pound will take direction from the vote of the MPC with a 7-2 split in favour of maintaining rates at current levels being expected. A great split in favour of a rate rise will help the Pound, a greater majority in favour of the status quo will have the opposite effect.

Inflation will be a key factor behind the Bank's thinking.

“The oil price has increased while Sterling has strengthened, and while we reckon that the net effect is likely around zero for inflation, market is now pricing in 55% probability of a rate hike already in May,” says Pedersen.

The BoE is only likely to find itself under pressure to raise interest rates if there were a danger that inflation would remain above the 2% target at the end of the BoE’s two year forecast horizon or if wages were to suddenly rise at a runaway pace.

“We think the appetite for making a big signal shift at this meeting is low and that the BoE might take a wait - and-see approach. This could send EUR/GBP slightly higher this week,” Pedersen adds.

Danske Bank still expect EUR/GBP to trade within the 0.8650-0.90 in coming months as the Brexit risk premium is likely to persist near term.

This gives a range of 1.11 - 1.1560 in Pound-to-Euro rate terms.

But, "longer term, GBP should strengthen,” Pedersen says.

The Pound-to-Euro rate is quoted at 1.1272 at the time of writing.

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