Pound Tipped to Win Back Ground Against Euro

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The British Pound is tipped to win back some ground against the Euro in the wake of today's Bank of England policy decision.

"GBP is likely positioned to win back a little ground vs. the EUR," says Jane Foley, Senior FX Strategist at Rabobank.

According to a new analysis from Foley, the Bank of England has little choice but to warn that interest rates cannot come down for many months, bolstering the market's expectation that the first rate cut will only come in September next year.

This is because of the UK's higher inflation rates relative to those in the Eurozone, where inflation fell below 3.0% in October.

"Market pricing is reflecting the view that BoE rates will have to remain on 'Table Mountain' for some months given the UK's inflation risks," says Foley.

The UK's CPI inflation rate in September read at 6.7% year-on-year, which was above consensus estimates, primarily as a result of rising fuel prices. Eurozone CPI inflation meanwhile fell to 2.9% y/y in October.

To be sure, the UK is expected to report a sharp drop in inflation for October when it reports later in the month, but Foley says UK inflation will still prove stickier than that of the Eurozone, which should keep the Bank of England's Bank Rate on hold at 5.25% for longer.

"While ECB policymakers will be reluctant to talk about the outlook for rate cuts as long as inflation remains above the 2% target, the market is beginning to speculate about such a move in Q2 2024. Market implied policy rates currently put ECB rates around 18 bps lower than current levels on a 6-month view," says Foley.

For the British Pound to remain supported against the Euro today, the Bank must avoid sending a 'dovish' signal that it could entertain interest rate cuts sooner than current market expectations.

There is a particular risk that the Bank's Monetary Policy Report reveals softer inflation and growth forecasts than the market is currently expecting, which would act as a signal rates can come down faster in future months.

But with inflation still elevated and the UK labour market still tight, such a signal could risk bringing the Bank's credibility into question, something it will be keen to avoid.

"On the assumption that the BoE indicates at tomorrow’s policy meeting that rates are set to remain on hold for some months, GBP is likely positioned to win back a little ground vs. the EUR," says Foley.

Rabobank forecasts the Euro to Pound exchange rate to edge back to 0.86 in the weeks ahead, giving a Pound to Euro forecast target of approximately 1.1630.