Pound Sterling and Euro: Wagged By the Dollar Tail

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The Pound-Euro exchange rate is proving a reliable currency pair to gauge, having exhibited exceptionally low volatility over the past eight months as it respects its tightest range since 2008.

While this does not offer much excitement for speculators, it does allow those with payment requirements the luxury of a relatively limited risk profile.

Underscoring this stability are market expectations for the Bank of England and European Central Bank to cut rates in lockstep in 2024, but researchers at Société Générale offer an additional important explanation.

Soc Gen analyst Oliver Korber says Pound-Euro is currently beholden to developments in U.S. interest rate markets; he explains U.S. rates - and the USD - are proving to be the key directional drivers in FX markets.

"The US dollar remains in the driving seat. The fast decline in USD short rates is sustaining their volatility, triggering dollar moves," says Korber in a strategy note released midweek. "This mechanically increases the correlation between EUR/USD and GBP/USD, such that the EUR/GBP is trading sideways."

EUR/GBP is currently trading in the middle of a 0.8493-0.8765 range that has held since May, translating into a GBP/EUR range of 1.1774-1.14.

1.1774 is the August 23 high, and 1.14 is the November 17 low.

The range has been respected since May 2023, but zooming out shows it has actually been the preferred range since August 2022, with a few brief forays to the downside during the Truss-era financial panic and the spell of inflation-related growth anxiety that characterised the early parts of last year.

Above: Pound-Euro at daily intervals since 2022. Track GBP and USD with your custom rate alerts. Set Up Here.

Another consideration driving the market is converging expectations for the scale of interest rate cuts due from the Bank of England and European Central Bank in 2024, with the rule of thumb being the biggest cutter will penalise its currency the most.

Interestingly, Wednesday saw traders scale back their expected ambitions from the ECB to just five interest rate cuts over the year.

This puts ECB expectations in line with what is expected of the Bank of England.

With both central banks tipped to cut in lockstep, it is perhaps little wonder Pound-Euro proving a steady pair.