British GBP/EUR exchange rate (GBP/EUR: Outlook Favours Sterling as Analysts Predict ECB ACtion

By Rob Samson

The pound to euro exchange rate is in the red on Thursday as a recent correction lower to the longer-term rally continues to play out.

The euro is preferred in the short-term even though it failed to receive a boost from today's key inflation release. By early afternoon in London we see the The British pound to euro exchange rate (GBP/EUR) is 0.19 pct in the red at 1.2010.

The GBP/EUR rate had earlier dropped below the 1.20 mark; "this week's smaller calendar has definitely not worked in the pound's favour and weaker than expected inflation has not helped," notes Sasha Nugent at Caxton FX.

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"Sterling seems to have lost its way and only the next major release will be able to align it. Coming tomorrow morning in the form of UK retail sales data for December, the market is waiting for a decisive figure to either force the pound back up or to crush it down. Sideways trading is expected but risks still remain to the downside throughout today's session," says Nugent.

Low inflation poses a risk to the euro

Eurozone CPI came in as expected increasing 0.8%y/y on headline and 0.7% y/y on core (see middle chart); leaving the disinflationary trends in place and posing a significant downside risk to ECB policy.

The German—US 2year bond yield spread is falling, having dropped from –0.07% in December to –0.19% today; which is adding downside pressure EUR.

"We expect that the combination of a relatively strong EUR and disinflation will eventually force the ECB to take a more dovish stance and remain so longer than the Fed, which is likely to drive EUR weakness. Recent upward pressure on Eonia yields (on the back of excess liquidity being drained), has increased speculation that the ECB will come in to ease liquidity," says Camilla Sutton at Scotiabank.

US dollar strength remains a fundamental feature in global FX

The USD is strong leading into the NA open as other markets are relatively quiet. Yesterday’s data was encouraging and has supported some upward USD pressure; however it is noteworthy  that the USD DXY index continues to trade just below its average one year level.

The IMF’s Lagarde highlighted the risk associated with tapering and reiterated that there must be vigilance against deflation. AUD has dropped to a 3+ year low on the back of notably weak employment; highlighting the importance of the domestic stories in the current environment.

Today’s focus will be US CPI (consensus: 1.5%y/y on headline and 1.7%y/y on core) followed by Chair Bernanke (11am EST).