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EUR GBP Exchange Rate Muted Despite Widening Eurozone Trade Surplus

July 14, 2017 - Written by Toni Johnson

Although the Eurozone trade surplus widened significantly in May this was not enough to trigger a particularly strong rally for the Euro Pound exchange rate.

Even so, as Jennifer McKeown, Chief European Economist at Capital Economics, noted:

‘The widening of the euro-zone’s trade surplus in May adds to signs that GDP growth may have accelerated in the second quarter. And in contrast to the situation last year, we expect net trade to boost euro-zone GDP growth in the quarters ahead.’

This could boost the appeal of the single currency in the longer term, even if a lack of European Central Bank (ECB) hawkishness continues to weigh on the minds of investors.

Confidence in the underlying strength of the Eurozone economy could boost hopes that inflationary pressure will see some upside in the coming months, in spite of a recent loss of momentum within the consumer price index.

However, the Euro could come under renewed pressure next week with the publication of the quarterly ECB bank lending survey.

Given the persistent worries surrounding the health of the Eurozone banking sector any signs of weakness that the survey flags up could encourage investors to pile back out of the single currency.

Euro Volatility Likely Ahead of ECB Policy Decision

The greater focus will ultimately fall on the ECB’s July policy meeting, though, with markets keen to get a fresh gauge on the outlook of policymakers.

As analysts at ING commented:

‘In the Eurozone, all eyes will be on the ECB. We expect ECB President Draghi to repeat the key elements of the Sintra speech, carefully preparing first steps towards tapering, while at the same time adding some dovish elements to calm down the recent small taper tantrum in financial markets.’

If the ECB does choose to emphasise that the quantitative easing program is not being tapered in the near future this could weigh heavily on the EUR GBP exchange rate, diminishing the prospect of any imminent shift towards hawkishness.

On the other hand, the Euro could rally if investors remain confident in the prospect of the ECB tightening monetary policy sooner rather than later.

Weaker UK Inflation Could Diminish BoE Rate Hike Odds Further

The mood towards the Pound could sour, meanwhile, in anticipation of Tuesday’s UK consumer price index report.

Forecasts point towards a slight easing in inflationary pressure during June, although the inflation rate is expected to remain significantly in excess of the Bank of England’s (BoE) official target.

ING analysts noted:

‘In the UK, we’re expecting inflation to stay perilously close to 3% as the effect of the pound’s depreciation continues to filter its way through to prices. That means inflation will continue to outpace wage growth by almost 1%. Payments firm Visa have suggested that the second quarter was the worst for consumer spending since 2013, although the volatility of official retail sales data means this household squeeze may not be quite so obvious in the latest figures released next week.’

If inflation is found to have softened the chances of the BoE returning to a tightening bias this year are likely to diminish markedly, to the benefit of the EUR GBP exchange rate.

While some slowdown in inflation would be positive for the UK economy, given how much consumer spending has helped to drive growth in the wake of the EU referendum, this is unlikely to be enough to shore up Sterling.

Investors look set to remain preoccupied with developments on the BoE Monetary Policy Committee (MPC) even as the uncertainty surrounding Brexit continues to weigh on the domestic economy.

Despite the increasing hawkishness of some policymakers the balance of the MPC still seems in no real risk of tilting out of the favour of the doves, limiting the upside potential of GBP exchange rates.

Thursday’s UK retail sales data could also put pressure on the Pound, providing the figures offer further evidence of slowing consumer spending and faltering domestic sentiment.

However, if sales are instead found to have held up on the year this may knock the wind out of any EUR GBP exchange rate rally.
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