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GBP to EUR Exchange Rate Edges Higher as Bank of England Officials Take Surprisingly Hawkish Tone

May 22, 2018 - Written by Frank Davies

Despite broad political jitters weighing on the Euro, and hopes that the Bank of England (BoE) could still be more hawkish than expected on Britain’s economy, the British Pound to Euro (GBP/EUR) exchange rate’s recovery was limited on Tuesday. Sterling traders highly anticipate key UK data due later in the week before making any big moves on the currency.

Following last week’s climb from 1.1336 to 1.1438, GBP/EUR shed almost half of those gains when markets opened on Monday as Brexit uncertainty hit the Pound again. On Tuesday morning GBP/EUR made recovery attempts, but the pair still generally trended near the level of 1.1391 at the time of writing.

Pound (GBP) Demand Briefly Jumps but Uncertainties Weigh on BoE Hopes

On Tuesday, Sterling enjoyed a brief jump in demand as Bank of England (BoE) speculation returned to focus and comments from bank officials were perceived as surprisingly hawkish.

During a testimony from bank officials to the UK Treasury Committee, policymaker Gertjan Vlieghe suggested that his own view of Britain’s interest rate path was one or two interest rate hikes per year over the next three years.

The possibility of six UK rate hikes taking the interest rate to 2% by 2021 briefly caused BoE interest rate hike bets to rise, but the bank’s members were quick to note that uncertainties remained high.

Viraj Patel, forex strategist from ING Bank, summarised the market mood:

‘His comments are helping Sterling but it is important to remember that everything policymakers say today is conditional on the incoming data and that needs to be kept in mind to correctly assess the policy outlook,’

In the end, BoE rate hike bets were largely unchanged. Investors still bet there is around a 90% chance of one rate hike from the bank this year, and this is largely dependent on Britain’s economic outlook.

As a result, investors were hesitate to buy into the Pound on BoE speculation alone. Instead, investors opted to wait for the key UK inflation and retail sales stats due later in the week before acting.

Other analysts argued that so long as Brexit uncertainties remained prominent in Britain’s economic outlook, Sterling strength is likely to be temporary. According to Commerzbank:

‘Until a solution emerges on the Brexit front, a rate hike is the only things that could support Sterling temporarily,

Without it, Sterling remains unattractive.’

Euro (EUR) Demand Mixed as Italian Politics Keep Pressure On

The Euro’s strength so far this week has been largely due to brief weakness in rivals, including the Pound and the US Dollar (USD).

As the Euro has a negative correlation with the US Dollar, the shared currency has benefitted from the US currency’s profit-taking selloff.

Euro gains against Sterling could have been even stronger, if not for political uncertainties making the shared currency unappealing.

This week, Italy’s two populist parties looked to agree to form a coalition and have been speaking with Italy’s President about suggestions for a new Prime Minister.

So far, the League party and 5-Star Movement party have put forward law professor Giuseppe Conte to head their potential coalition government.

Italian President Sergio Mattarella has yet to comment on the recommendation, but as Conte has no political experience this pick has worsened market uncertainty.

GBP/EUR Forecast: UK Inflation and Retail Results in Focus

Following the Bank of England’s (BoE) signal that UK interest rates could still rise multiple times over the coming years, Pound investors just need more firm reason to believe that Britain’s economy can support tighter rates.

This week’s UK data is set to be highly influential, especially inflation due on Wednesday and retail sales stats due Thursday.

For example, if Britain’s inflation rate slows more than expected, investors will become increasingly concerned that UK inflation is too subdued to support higher interest rates.

On the other hand, stronger inflation would boost BoE interest rate hike bets and the Pound.

As BoE policymakers have argued that the Q1 slowdown in consumer activity was caused largely by poor weather, April’s retail sales results could also be particularly influential.

If UK retail sales beat expectations it will indicate that consumer activity is resilient despite the Brexit process, and the Pound outlook would likely rise.

Meanwhile, Euro trade is likely to be influenced by Italian political developments, but Wednesday’s Eurozone PMI projections for May could drive the shared currency too.
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