Pound to Euro Rate Drops on Strong Eurozone GDP, Inflation Beat

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Euro exchange rates recovered after Eurozone inflation beat expectations and regional growth figures surpassed expectations to show a strong recovery in the first quarter.

The Pound to Euro exchange rate dropped from range highs near 1.1720 to go back below 1.17 after Eurostat said Eurozone GDP grew 0.3% quarter-on-quarter in Q1, recovering from Q4's -0.1% and beating expectations for 0.1% growth.

Year-on-year inflation stands at 0.4% for Q1, doubling expectations for 0.2%. "Today is a good day for the eurozone," says Dr. Thomas Gitzel, Chief Economist at VP Bank. "Spain and Portugal once again proved to be the growth drivers. Both expanded by 0.7% quarter-on-quarter. The Iberian peninsula thus remains the powerhouse of the eurozone."

At the same time, year-on-year inflation was revealed to have stayed steady at 2.4%. But the core inflation reading - which matters for European Central Bank interest rate deliberations - fell to 2.7% in April from 2.9%, but this was higher than the 2.6% the market was looking for.

"Investors have reacted to the upside surprise in the April core inflation print by sending the euro slightly higher against its peers," says Matthew Ryan, Head of Market Strategy at Ebury.

Putting these data together, we have a decent economic recovery and slightly firmer-than-expected inflation. This is unlikely to stop the ECB from cutting interest rates in June, but it begs the question as to whether it would be appropriate to cut interest rates in July.

The debate for the Euro now rests on what happens after June, and any suggestion that the number of cuts that follow will be limited will likely support the Euro.

This supportive setup was displayed by the Pound to Euro exchange rate, which has fallen in response to fresh bidding for the Euro following the data release.

The Eurozone and UK economies look to be highly synchronised and this will limit Pound-Euro's ability to go above 1.17. It will also likely limit downside close to the 1.1650 area.

Above: GBP/EUR at four-hour intervals. Track GBP/EUR with your own custom rate alerts. Set Up Here

"Today’s data may be used as an argument in favour of a slightly slower pace of cuts in 2024, particularly if we were to see similar beats in the next one or two inflation reports," says Ebury's Ryan.

Economist Bert Colijn at ING says higher energy prices and improving domestic demand raise questions about the direction of inflation going forward. "Domestic demand is showing signs of recovery in the eurozone, which could make inflation more stubborn," he says.

ING still thinks the economic environment is benign enough for a rate cut in June and expect the ECB to be data-dependent after that.

"Today's inflation data is a warning that the ECB will likely be careful with rate cuts and may take its time in normalising rates. With an economy showing signs of picking up and unemployment at record lows, the ECB can afford to do so," says Colijn.