Pound at Fresh 6-Month Best against Euro, Bank of England is Key Risk
- Written by: Gary Howes
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Pound Sterling has broken out of a long-held range against the Euro, a move that hints further gains are possible on a technical basis, although Thursday's Bank of England policy decision could pose a fundamental setback.
The Pound to Euro exchange rate (GBP/EUR) rallied to a new high of 1.1449 on Tuesday, meaning those quick-acting buyers of euros were welcoming their best exchange rate since December.
The six-month high comes amidst an ongoing outperformance by the British Pound, which is 2023's best-performing major currency owing to an improved UK economic outlook and falling gas prices.
The developments mean an overtly bearish consensus on UK assets - particularly the Pound - has been reconsidered.
The Bank of England meanwhile remains in a data-dependent mode which has ensured markets see up to three more interest rate hikes coming from the Bank before September.
Rhys Herbert, an economist at Lloyds Bank, says Pound Sterling rose against the Euro as markets speculate on the outcome of Thursday’s Bank of England monetary policy update.
"Even with UK markets closed sterling outperformed," says Mathias Van der Jeugt, an analyst with KBC Markets. "However, we don't draw any in-depth conclusion before Thursday's BoE policy decision, including a new economic assessment/monetary policy report."
Of note is the exchange rate's recent break through the long-term 200-day moving average; a move that suggests a decidedly more supportive outlook, at least from a technical perspective.
"EUR/GBP has officially cracked through the 200-day moving average and seems to get some escape velocity to the downside now," says W. Brad Bechtel, Global Head of FX at Jefferies LLC.
The inverse of the above is shown in GBP/EUR breaking above its 200-day moving average:
Above: GBP/EUR breaks out of its recent range and above the long-term 200-day moving average.
The market expects a further 60 basis points of hikes from the Bank of England before year-end with only the European Central Bank expected to deliver more.
This has supported Sterling until now but also leaves it at risk of declining if the Bank of England pushes back against these expectations on Thursday.
After all, the Bank has form in this area, warning throughout 2022 that it expects a deep recession to take hold in 2023 and therefore rates will not need to rise as high as the market expects.
This has meant that over recent months the Pound has tended to fall in the wake of 'dovish' Bank of England assessments.
Can the leopard change its spots, i.e. can the Bank truly shake its 'dovish' instincts? If not, the Pound could come under pressure on Thursday.
A dovish outcome would see the Bank hike by 25 basis points but warn via its forecasts and verbal guidance that it won't need to hike by as much as the market expects.
If this were the case, the Pound-Euro exchange rate would fall below 1.14 and into its long-running sideways range.
However, the Bank's economic forecasts have proven woefully inadequate given the long-predicted economy simply has not materialised and inflation rates remain elevated amidst a strong labour market.
The Bank will raise its forecasts again on Thursday as it accounts for recent data outturns. It could also warn that it will continue to raise interest rates as long as data warrants it.
This would, in effect, mean a repeat of March's policy decision. The Pound actually rallied in March as the Bank was seen to have given a more credible message in which it puts more emphasis on the importance of incoming data.
If the Bank does a copy-and-paste Pound Sterling could hold its recent gains.
GBP/EUR Forecasts Q2 2023Period: Q2 2023 Onwards |
