ECB Opens the Door to Bank of England Pause

• GBPEUR unable to attack 1.17
• GBP also struggles amidst broader EUR pullback
• ECB signals rate hiking cycle is likely done
• But GBP faces similar risks next week
• When Bank of England is due to deliver its decision

ECB president Christine Lagarde answering questions from journalists during the ECB Governing Council press conference in Frankfurt, 27 July 2023. © Felix Schmitt for ECB.

It should have been the Euro stealing the limelight on the day the European Central Bank (ECB) signalled it was ready to pause its interest rate hiking cycle having earlier raised the deposit rate to its highest-ever level.

But it was the British Pound that suffered broad-based losses, falling against all but one of its G10 peers.

To be sure, the Euro was sold widely following the ECB's decision and guidance with a near-1.0% loss being registered against the U.S. Dollar,  as markets reduced odds for a September rate hike to below 50%.

But what happened to the Euro this week could befall the Pound next week if the Bank of England (BoE) signals it too is ready to pause.

This is almost certainly the thinking in FX markets which sold the Pound on a belief the ECB and Federal Reserve have allowed the BoE the space to signal a peak is close for UK interest rates.

Markets had expected up to three further rate hikes from the BoE heading into this week, more than any other major central bank, meaning expectations have further to fall. If heightened BoE expectations were a major driver of Sterling outperformance in 2023, then their comedown can contribute to underperformance in the currency.

The BoE will almost certainly point to the below-consensus inflation reading released this month, as well as broader global deflationary dynamics that will reach the UK over the coming months, as evidence that it can now also consider leaving interest rates unchanged.

"GBP also finished lower with the markets taking the recent stances by the Fed and the ECB as a cue for what the Bank of England may also say next Thursday, which is to be data dependent and also hint at pausing rate hikes," says Thanim Islam, Head of FX Analysis at Equals Money.

The Pound to Euro exchange rate (GBPEUR) fell 0.15% to 1.1655 on the day the ECB signalled its July rate hike could well be the last, but the ECB said further rate hike decisions will depend on the nature of incoming data.

Today's German, French and Spanish inflation releases will be important in this regard, followed by Monday's all-Eurozone inflation print.

Softer readings could boost GBPEUR, but likewise, expect a shallow setback on any above-consensus reading.

"Markets will now look to ECB sources and German inflation data tomorrow which could further impact rate expectations. We are very close to the peak, pause and change in the rate cycle which means policy mistakes are more likely now we are at this turning point. Volatility should also increase in the euro as markets are guided less by central bank communication, and more by eight weeks of data releases," says Jamie Dutta, Market Analyst at Vantage.

Above: The formation of a spinning top pattern on ECB day suggests increased uncertainty amongst traders towards GBPEUR.

ECB President Lagarde confirmed an "open-minded" attitude on the path of future policy, as the central bank was no longer "in the domain of forward guidance".

"The Governing Council's future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary," read a statement from the Bank.

One key point to note in the above: previously this element of the statement read, "interest rates will be brought to sufficiently restrictive levels".

This subtle, yet important, change steers the ECB's communication towards a hint that it has arrived at the peak and is now ready to pause the rate hiking cycle.

In the post-decision press conference, ECB President Christine Lagarde confirmed the switch from "brought at" to "set at" was intentional.

In previous press conferences, Lagarde had also latched onto questions regarding future policy direction to pre-announce further hikes.

But this time, when asked if the ECB has more ground to cover, Lagarde said "at this point in time I wouldn't say so".

"Lagarde explicitly stated that the bank may not have more ground to cover in policy firming," says Jamie Dutta, Market Analyst at Vantage. "Markets reacted by selling the euro and taking yields lower with now less chance of a September rate hike which futures now give less than a 35% chance."