© Bank of England

The Pound to Euro exchange rate’s recovery from last week’s lows around 1.15 may have been derailed and it could now be at risk of slipping further, according to strategists at ING, who say the Bank of England is set to weigh on Sterling.

GBP/EUR fell from one-week highs on Wednesday after inflation rose less than expected for July, and after other key measures of price pressures underwhelmed expectations including the core inflation rate and services sector inflation.

“We continue to see the pair as a preferable channel to play BoE-related GBP weakness as opposed to GBP/USD, where some dollar softness can still offer support,” ING’s Francesco Pesole said on Wednesday.

“A return above 0.86 in EUR/GBP looks warranted,” he added, citing Wednesday’s UK inflation figures for July.

Pesole’s call for EUR/GBP to rise back above 0.86 implies that Sterling is expected to fall back below 1.1629 against the euro, which would bring a key technical support level around 1.1609 back into focus.

Above: Pound to Euro rate shown at hourly intervals alongside EUR/GBP.

Any erosion of that level or break lower to the downside would leave little on the charts to support the Pound to Euro rate ahead 1.1522, which is the 78.6% Fibonacci retracement of the November uptrend.

Pesole says the softer-than-expected inflation figures will be likely to encourage markets to price in further rate cuts from the Bank of England unless and until it comments on what the data means for the outlook.

“Services CPI now stands at 5.2%, down from 5.7% and crucially, well below the BoE’s 5.6% forecast,” ING economist James Smith said on Wednesday, before warning that the data was not as good as it looked.

“Remember that services inflation is the main guiding light for Bank of England policy these days. But dig into the details and we suspect the Bank will be taking these figures with a pinch of salt,” Smith added.

Overnight index swap rates shifted lower already on Wednesday to imply that two further interest rate cuts are now all but certain to be announced ahead of year-end, weighing on Sterling against most major currencies.

Above: Pound to Euro rate shown at daily intervals with Fibonacci retracements of July downtrend and 100-day moving average (black) indicating possible areas of technical resistance, while the 200-day average (blue) denotes prospective support. Click image for closer inspection.

However, the ING team says the decline in services inflation was the result of hotel prices reversing a surprise surge from June, and that the Bank of England might be likely to look through this development.

This is after the BoE said in early August that it would not react to a singular month of data if it surprises positively, and that it would remain focused on the medium-term outlook for services inflation, wage growth and overall inflation.

The Bank of England cut Bank Rate to 5% on August 01, from 5.25%, but warned that further cuts would be slow to materialise because it expects that inflation wil rise again, to 2.75%, by year-end.

This means there may be a risk of the BoE dismissing July’s inflation data as not enough to merit any further adjustment in interest rates just yet, which would be likely to support Sterling and GBP/EUR.

Meanwhile, the author’s model suggests a rebound to 1.1694 for the days ahead, and that the pair should remain buoyant above 1.1648. However, the model-implied fair value is currently situated up around 1.1916.