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Oil price gains underpin the pound, but Eurozone wage expectations could provide the euro with longer-lasting support.
The pound-to-euro exchange rate edges higher on Tuesday, mirroring firmer Brent oil prices, which have returned above $100 a barrel on concerns over Saudi crude supplies.
"The strong start to the week for risk assets is set to face a mini speedbump on Tuesday as the price of oil is higher by 1.5%, and Brent crude oil is back above $100 per barrel," says Kathleen Brooks, Research Director at XTB.
Brooks puts the move down to reports that the Houthis are extending gains in Yemen to take control of the Red Sea.
"This is neutralising some of the good news that Saudi Arabia is ramping up its Gulf oil exports, after the attacks on its East-West pipeline," she adds.
Saudi Arabia told European and Indian refiners last week that crude supplies would be suspended, a consequence of the Houthi attacks on its pipelines.
That makes Europe a direct casualty of the supply disruption.
Since the conflict began, the pound-to-euro rate has tended to rise with oil, which says the market reads the Eurozone as more exposed to higher oil and gas prices than the UK.
The Eurozone's manufacturing base is the reason for that asymmetry, set against a UK economy weighted to services.
ECB Chief Economist Philip Lane warned on Monday of a second wave of price rises, in gas as well as oil, which the central bank expects to push inflation higher and keep it there before a decline towards target from mid-2027.
The reverse also holds: Monday's slide in oil drew the pound-to-euro rate back to its pivot.
The pound-to-euro rate trades at 1.1658, equivalent to 0.8578 in euro-to-pound terms, with 1.1689 the cap that turned it back last Tuesday and 1.1615 the floor established after the Bank of England's decision.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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Talk to a specialistOil also moves the pair through bond yields, with the pound-to-euro rate rising alongside UK two-year gilt yields through recent sessions.
UK two-year yields fell 7 basis points on Tuesday morning, but Brooks says the combination of rising UK borrowing and higher oil prices could reverse some of that move later in the day.
UK public borrowing came in at £18.3bn in August, leaving the year-to-date total £8.1bn above the official forecast.
"The mild reaction to the UK public finance data suggests it will take a bigger catalyst to move the pound, which has been fairly resilient in the face of bond market volatility," says Brooks.
Euro Could Find Enduring Support on Eurozone Wage Dynamics
The oil trade offers the pound support for as long as prices stay elevated, but the euro has a slower-moving source of support building beneath it.
Euro area macro risk has returned to the spotlight, according to Lloyds Bank, on three fronts:
• Regional election results that have raised questions about Chancellor Friedrich Merz's grip on power.
• A downgrade of France to A+ by Scope Ratings last Friday, just as headlines on the 2027 budget process start to build.
• An ECB business survey, published Monday, showing how the Middle East conflict is filtering into firms' expectations.
It is the third that matters most for the currency, and medium-term, it could prove supportive for euro exchange rates.
"It was striking that irrespective of whether firms viewed themselves as having a high or low exposure to the conflict, there was a consistent view that upward pressure on wages was a consistent expectation," says Lloyds Bank.
Image courtesy of Lloyds Bank.
The survey follows last week's ECB wage tracker, which again showed modestly upward-sloping expectations for pay.
"This survey evidence pointing to broad-based upward wage impacts from the conflict adds to the expectation that the Governing Council will feel the need to hike rates again before year-end," Lloyds adds.
Wages are what turn an energy shock into lasting inflation.
An oil spike fades once supply recovers, but pay settlements lock in for a year or more, and that persistence is what would keep the ECB raising rates after the oil trade has run its course.
Morgan Stanley changed its call last week and now expects a 25bp ECB hike in December, taking the deposit rate to 2.75%.
Daniella Arcadipane, Senior Currency Specialist at Indigo
Moving a life-changing sum abroad? You won’t be doing it alone.
One specialist explains every step in plain English and stays with it until the money lands. FCA authorised, FRN 594433.
Talk to a specialistThe UK picture differs.
The Bank of England voted 6-3 to hold Bank Rate at 3.75% on 17 September, leaving it alone among the major central banks in holding this month.
UK private sector wage growth stood at 2.8% in June and is trending lower, according to Danske Bank, with public sector pay the main source of strength in the headline figure.
Francesco Pesole, FX Strategist at ING, sees most risks tilted towards euro upside against the pound and holds a 1.15 target, with sterling exposed to policy and to fiscal headlines ahead of the budget.
Market pricing already leans the same way, with forward points implying 1.1623 in three months and 1.1500 in a year.
There is a limit to how far the ECB story can run, however.
Money markets are discounting a 3.5% ECB peak rate, which KBC says looks overdone even though the central bank sticks with a hawkish stance.
Our house view is that the uptrend from November 2025's low holds, but a meaningful recovery requires the 28 October budget to pass without incident.
President Trump addresses the UN in New York on Tuesday, and any progress towards a meeting with the Iranian president later this week would pull oil lower and the pound-to-euro rate back towards its 1.1615 floor.
Daniella Arcadipane, Senior Currency Specialist at Indigo
Moving a life-changing sum abroad? You won’t be doing it alone.
One specialist explains every step in plain English and stays with it until the money lands. FCA authorised, FRN 594433.
Talk to a specialist
