• GBP/EUR supported around 1.1550 short-term
• Faces battle with gravity & struggle to hold 1.16
• BoE, ECB speeches & relative rate pricing eyed

Image © Adobe Images

The Pound to Euro exchange rate gave up much of its June gains ahead of month-end in another sign of Sterling now being in the grip of gravity and potentially facing a struggle to avoid losses taking it back below the 1.16 handle in the days ahead.  

Sterling fell further from almost one-year highs against the Euro last week after Bank of England (BoE) Governor Andrew Bailey indicated on Wednesday that market expectations for Bank Rate may have become overzealous following the increase in wage growth and rebound of core inflation announced last month.

Market pricing has shifted to imply a high probability of Bank Rate rising from 5% to 6.25% by year-end as a result but the governor's remarks suggested that he at least sees June's half percent increase from 4.5% to 5% as already being an adequate response to the recent data. 

"The inflation side of the equation for the EU remains firm and rate hikes remains critical for now if they are to continue to fight it. A lot of debate on whether they will hike in Sep and for now it appears to me like they must," says Brad Bechtel, global head of FX at Jefferies. 

"The UK is in a different place on this as the BoE is looking for a drop in inflation at the next print and if not seen we are likely to see a bigger reaction in the GBP than we did in the EUR to the data this morning," Bechtel writes in Friday market commentary. 

Above: Selected moving averages denote possible support and/or resistance for Pound to Euro rate. Shown with spread or gap between 02-year UK and German government bond yields.

There are no important economic figures due for release in the UK this week but BoE Governor Bailey is scheduled to participate in a panel discussion at the Economic Meetings of Aix-En-Provence on Friday and the risk is of his remarks reinforcing the message of last week and further dampening market appetite for Sterling.

"Catherine Mann will be a panellist at the 2023 Annual Meeting of the Central Bank Research Association in New York on Friday. Her session is entitled: “‘Challenges for policy after the return of inflation: new directions for research," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

One possible offset for the Pound to Euro rate and any Sterling losses, however, is the prospect of a softer performance from the single currency after overall European inflation fell further than was expected by economists for the month of June and the core rate rose by less than had been anticipated.

"We made the point in last week's Bank of England review that the FX hedging costs were now very painful for foreign investors in the UK Gilt market – a factor that could help sterling," says Chris Turner, global head of markets and regional head of research for UK & CEE at ING, in a Friday market commentary.

Above: Quantitative model estimates of ranges for this week. Source Pound Sterling Live.

Inflated market expectations for the BoE Bank Rate and the relatively more tame outlook for European Central Bank (ECB) borrowing costs are supportive of the Pound to Euro rate, though only in theory and for as long as the gap between expectations remains as wide as it is currently.

European inflation figures helped to sustain the breadth of the gap on Friday and play a role in keeping the Pound to Euro rate buoyant above 1.16 for much of this week but Sterling would be vulnerable to fresh losses on Friday if Governor Bailey is more explicit in begging to differ with expectations for Bank Rate.

The risk of this kind of outcome might even be especially high, however, given that increases in the Bank of England Bank Rate impact the UK economy more quickly than increases in equivalent interest rates over in Europe.

The Bank of England has also already raised rates as much if not more than any other developed market central bank over just more than the last year.

"There is still a large share of ultra-low fixed rate mortgages scheduled to roll off over the coming year or so to much higher variable or fixed rates," says Joseph Capurso, head of international economics at Commonwealth Bank of Australia. "The resulting substantial rise in household mortgage repayments will weigh on spending."

Above: Fibonacci retracements of selected downtrends indicate possible areas of technical resistance for the Pound to Euro rate while selected moving averages denote possible support and/or resistance. Shown on weekly interval chart.