British GBP/EUR: GBP/EUR Comeback Fades Despite Eye-Opening ECB Announcements

The following exchange rate levels are seen today (05/09):

• The pound to euro exchange rate (GBP/EUR): 0.31 pct lower on a day-to-day basis at 1.2579.
• The euro to dollar exchange rate (EUR/USD) is 0.09 pct higher at 1.2955.
• The pound to US dollar exchange rate (GBP/USD): 0.22 pct lower at 1.6296. The sterling dollar rate has fallen in symathy with the euro dollar - USD strength is supreme at present.

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The Euro Takes a Beating

Darren Ruane, Head of Fixed Interest at Investec Wealth & Investment, comments on the news that the ECB has cut its main interest rate from 0.15% to 0.05%:

“The ECB has today responded proactively to European deflationary threats and will begin buying a broad portfolio of simple asset-backed securities and covered bonds, starting in October.

"ECB President Draghi also admitted discussing the introduction of quantitative easing, which has traditionally boosted demand for both equities and bonds. Equity markets in Europe are currently trading more than 1.5% higher and government borrowing rates in Europe have fallen by more than 0.1% for peripheral countries. The Euro has weakened against the US Dollar.”

Highlights of New ECB interventions

• Main refinanciant rate cut to 0.05%
• Marginal lending rate cut to 0.30%
• Deposit facility cut to -0.20%
• The ECB will itroduce 400 GBP worth of asset purchases over the course of three years taking the balance sheet back to 2012 levels.

GBP Suffers Weakness vs the Dollar

The Bank of England meanwhile left policy unchanged ensuring the downward correction in the sterling dollar rate (GBP/USD) that we have witnessed in recent weeks continues.

Add into the mix the issue of the Scotland referendum we can see why there is little sympathy to drive the GBP/USD higher.

Add to this the very dovish BoE press conference during the last Quarterly Inflation Report and over-stretched long market positioning we can understand why GBP/USD has fallen.

The Outlook: GBP/USD Sideways, EUR/GBP Downards (i.e Sterling Gains vs Euro)

Looking forward, Bank of America's Nick Bate tells us he sees balanced risks for the pound dollar rate, but downside risks for the euro pound rate (i.e gains for GBP vs the EUR).

Commenting on the outlook, Bate says:

"Both the Fed and the BoE will be tightening next year, while we expect the recovery to continue in both countries without inflation pressures.

"Short-term GBP moves will depend to a large extent on the tone of the two central banks and how markets perceive it.

"Market position in GBPUSD is not as long anymore. Although the market remains short EURGBP, the long-term risks remain to the downside as monetary policies divergence and we will be selling any short-term rallies, for example if the ECB disappoints this week."

What to Expect from the Bank of England

Despite the more hawkish than expected 7-2 vote to leave interest rates on hold in August, Bank of America and most market commentators anticipate the September BoE meeting being relatively quiet.

"Evidence over the month suggests little reason for more members to support an immediate rate rise, and when the BoE leave policy on hold they typically do not issue an accompanying statement," says Bate.

The labour market is particularly important at the moment and a modest easing in the latest data may support various BoE members’ views to leave monetary policy on hold again in September.

"At the same time, while underlying wage growth rose at a circa 2.5% annualised pace - in line with the BoE’s expectations - we think they would want to see a few months of such data before their concerns over continued weak wage growth prospects were assuaged," says Bate.