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Pound Euro News: GBP/EUR Exchange Rate Rises as UK Inflation Climbs to 10.4%

March 22, 2023 - Written by John Cameron

The Pound Euro (GBP/EUR) exchange rate jumped on Wednesday morning after a surprise rise in UK inflation boosted Bank of England (BoE) interest rate rise bets.

At the time of writing, GBP/EUR was trading at around €1.1369, having gained 0.2% on the day.

Pound (GBP) Jumps as UK CPI Boosts BoE Bets

The Pound (GBP) rallied on Wednesday morning as a hotter-than-expected UK consumer price index rekindled Bank of England rate hike bets.

The latest CPI report showed that headline inflation rose from 10.1% in January to 10.4% in February, rather than falling to 9.9% as economists had expected.

Meanwhile, core inflation – which strips out volatile prices such as energy and food – rose from 5.8% to 6.2%, instead of cooling to 5.7%.

The unexpected increase in price pressures is further evidence that the UK is an outlier among other economies. Elsewhere, such as in the US and the Eurozone, inflation has fallen rapidly. In the UK, inflation hit a higher peak and, until Wednesday’s rise, had eased far more slowly.

Amid this backdrop of sticky, elevated inflation, markets were betting that the Bank of England would push ahead with a 25bps interest rate increase. This was a sharp about-turn from Tuesday, when market odds were in favour of a rate pause.

James Smith, Developed Markets Economist at ING, commented:

‘A day before the Bank of England announces its latest decision, it is faced with an unwelcome resurgence in UK core inflation. Core CPI is back up at 6.2% (from 5.8% in January), and more importantly shows that the surprise dip in services CPI last month was a temporary one.

‘We’re still narrowly expecting a 25bp hike on Thursday, and we think the BoE will take a leaf out of the European Central Bank’s book and reiterate that it has the tools available if needed to tackle financial stability, thereby allowing monetary policy to focus on inflation-fighting. This was the mantra it adopted last October/November during the mini-budget and LDI pensions fallout in UK markets.’

Euro (EUR) Underpinned by Hawkish ECB

Meanwhile, the Euro (EUR) was cushioned by hawkish comments from European Central Bank (ECB) policymakers.

Many ECB rate setters have expressed their support for more interest rate rises after the ECB enacted a 50bps increase at its meeting last week.

In an interview published by the Financial Times on Wednesday morning, ECB official and Bundesbank President Joachim Nagel said that he believes the European Central Bank should hike rates even higher.

Nagel said:

Our fight against inflation is not over… There’s certainly no mistaking that price pressures are strong and broad-based across the economy. If we are to tame this stubborn inflation, we will have to be even more stubborn.’

These hawkish comments lent support to the single currency, limiting its losses against Sterling.

GBP/EUR Exchange Rate Forecast: BoE Decision on a Knife Edge

Looking ahead, UK political jitters could impact the Pound. Divides in the ruling Conservative party have once again been exposed amid the vote on Prime Minister Rishi Sunak’s Northern Ireland Protocol deal, dubbed the ‘Windsor Framework’. Notable Brexiteers oppose the plan, with worries about further Tory infighting potentially troubling GBP investors.

On Thursday, the BoE rate decision is the focus. If the bank opts for a 25bps hike, Sterling could rise even higher. However, if the bank signals that that may be the last interest rate rise, GBP could face headwinds.

If the UK central bank decides to leave interest rates unchanged GBP/EUR could slump.

As for the single currency, the Eurozone’s flash consumer confidence report for March could provide EUR with some support. Economists expect consumer morale to have risen this month.

That said, the recent turmoil in the financial markets may have knocked confidence. The indicator could unexpectedly slip, which would likely dent the Euro.

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