Pound to Euro Rate Held Below 1.1650 Ahead of Key UK Releases

January 16, 2024 - Written by Frank Davies

STORY LINK Pound to Euro Rate Held Below 1.1650 Ahead of Key UK Releases

The Pound to Euro exchange rate hit resistance close to 1.1650 on Friday and retreated to just below 1.1630 in Europe on Monday.

Equities were unable to make headway after the European open with market fretting over the risk of further tensions in the Red Sea which also hampered risk conditions.

UK economic data will be very important this week with the latest releases on wages, inflation and retail sales.

The data will inevitably have an important impact on market expectations surrounding Bank of England (BoE) policy and will also be important for the BoE inflation report which will be released on February 1st alongside the latest policy decision.

According to ING; “Services inflation is what matters the most for the Bank of England at the current stage and we expect to see it at 6.1% this week, considerably below the Bank of England's estimates. Despite the improvement in services disinflation, 6%+ remains too high and is unlikely to make the BoE endorse dovish rate expectations just yet.”

Overall expectations of UK interest rate cuts have faded with 3-month futures for December 2024 increased by 21 basis points since the end of 2023.

MUFG notes that an ECB 25 basis-point rate cut is fully priced in for April while markets do not expect a BoE move until June.

In addition, the bank also notes the importance of fiscal policy. There will be strong expectations of further tax cuts in the March 6th budget, especially as lower market interest rates will tend to give the government increased fiscal headroom.

MUFG commented; “While looser policy would provide more support for the UK economy that has been stagnating over the past year, it could discourage the BoE from cutting rates in the year ahead.”

Higher yields will provide net support to the Pound, but there will also be hopes that the economy will rebound strongly and delays in rate cuts would tend to curb this optimism.

According to MUFG; “The releases of the latest UK CPI and labour markets reports in the week ahead will provide an important tests for the GBP. Further evidence of disinflationary pressures poses the main downside risk to GBP outperformance at the start of this year.”

Although energy prices increased in January, Paul Dales, chief UK economist at Capital Economics expects overall base effects will be more favourable for the UK than the US and Euro-Zone over the next few months.

He noted; "These drags aren't as powerful elsewhere, if we’re right, then in April, inflation in the UK will be lower than in the US and the euro-zone for the first time in two years."

He did, however, warn that underlying inflation would probably not fall as quickly as the headline rate and warned that increased shipping costs due to tensions in the Red Sea could put upward pressure on prices.

Overall, Dales expects a first rate cut in June.

Markets will be monitoring developments in the Davos World Economic Forum this week with a particular focus on central bank rhetoric.

According to ING; “Lagarde has a greater potential to influence markets given a clearly divided Governing Council, and we suspect that she will opt for a more hawkish tone compared to last week’s comments. There may be some help for the euro coming from Davos, although we should be wary.”

Over the weekend, ECB Chief Economist Lane noted that key wages data won’t be available until June.

Nevertheless, he added; “The ECB's rate rise in September was in part "an insurance" against inflation coming back and this will be considered when the time comes to ease policy.

If, therefore, inflation remains favourable, there will be the potential for the September rate hike to be reversed relatively quickly which could back a March rate cut.

According to ING GBP/EUR can approach 1.1665, but expects tough resistance here “as the euro may benefit from some hawkish comments by Lagarde.”

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TAGS: Pound Euro Forecasts