Image: ECB.
Lagarde's pushback against an October hike offers the pound its clearest route higher against the euro.
The pound-to-euro exchange rate is holding near 1.1664 on Tuesday, extending Monday's oil-driven gains, and further upside now rests heavily with the European Central Bank.
ECB President Christine Lagarde told the European Parliament's economic committee on Monday that the energy shock has yet to feed through to wages, and that "we view a measured response as appropriate to keep inflation in check."
"Lagarde seemed willing to tone down some market enthusiasm about an October hike yesterday, saying that tight financial conditions are limiting the pass-through of energy costs to the broader economy," says Francesco Pesole, FX Strategist at ING.
The GBP/EUR rose to 1.1660 by Tuesday from 1.1620 ahead of the comments.
Lagarde also flagged the rise in long-term borrowing costs since the ECB's September meeting as a brake on growth, which markets read as the bond market doing some of the ECB's tightening for it.
The euro, according to Pesole, "held up relatively well" given the slew of dovish-leaning comments.
Those comments pushed the SOFR-ESTR two-year swap spread, the gap between US and Eurozone rate expectations, beyond 155 basis points, close to the 163bp maximum reached in early July.
"Her remarks confirm our suspicion that if one central bank hikes in October, it will be the Fed, and not the ECB," he says.
Markets price 17bp of Fed tightening in October and just 9bp from the ECB, according to ING.
Rate Gap Favours Sterling
The ECB tilt matters for sterling because the Bank of England sits at the opposite end of the spectrum.
UK money markets attach a 90% probability to a Bank of England hike on 5 November, according to KBC, after Deputy Governor Dave Ramsden said on Monday that a case for higher rates builds if upside inflation pressures persist.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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Talk to a specialistThat leaves a near-certain UK hike set against an ECB that is signalling patience, following Governor Andrew Bailey's warning last week that it will get harder to keep rates on hold.
Last week, KBC warned that the 40% probability of a back-to-back ECB hike in October could prove an underestimation.
Lagarde has since pushed pricing in the other direction, and the pound-to-euro rate has moved higher as she did so.
Domestic Drivers Offer Little
Sterling's own fundamentals provide little lift beyond the rate story, which is why the ECB carries so much weight in the outlook.
Speculators have built the largest net GBP short positions in almost three months, according to CIBC, with UK public finances in focus ahead of the 28 October budget.
Ten-year gilt yields hit a post-2007 high of 5.42% on Monday.
"Given that 10yr Gilt yields have traded through 5.40% underlines the lack of fiscal headroom facing the Chancellor in the upcoming budget," says Noah Buffam, Director of FICC Strategy at CIBC.
Pantheon Macroeconomics says gilt spreads over peers could widen further if fiscal credibility deteriorates, with few signs that the government will implement its planned consolidation.
That fiscal backdrop caps how far sterling can advance on its own merits, which is why we expected periods of strength this week to meet selling interest.
The Euro-Dollar Channel
ING's baseline is for a higher euro-to-dollar rate by year-end, with both the Fed and the ECB holding until December.
"But any hint of strong US data could prompt a test of the 1.1320-30 summer lows, with Lagarde's comments lifting some support off the euro," says Pesole.
The euro-to-dollar rate trades at 1.1348, within touching distance of those lows.
A broad euro selloff on strong US data would favour the pound-to-euro rate, given sterling's rate support from an expected November hike.
Friday's US payrolls report is the key test.
Levels
The pound-to-euro rate faces resistance at 1.1689, the level that capped gains earlier this month.
A break above requires the ECB repricing to extend, with 1.1615 the floor established after the Bank of England's September decision, as covered in our week ahead forecast.
Spanish inflation for September is due today, with consensus at 4.9%, and a hot print would test Lagarde's claim that price pressures are not becoming embedded, and with it the pound-to-euro rate's hold on 1.1660.
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
