One of the best-performing currencies this week has been the Euro, which has forced the GBP/EUR exchange rate right back down to levels last seen in early December.
The Pound to Euro Rate is today quoted at 1.1723.
Ironically, the fresh strength in the Euro comes in response to important policy-makers acknowledging the benefits of the weaker currency.
The Euro’s, “outperformance reflects the benefits brought on by a weaker currency,” says Kathy Lien, Direction at BK Asset Management in New York.
The Euro has fallen notably against the Euro and Pound Sterling over the course of the past two months and in doing so dramatically altered the outlook for inflation and growth in the Eurozone.
But, in the latest economic bulletin released by the European Central Bank (ECB), the central bank sees inflation picking up strongly at the turn of the year and this prompted ECB member Weidmann to say in an interview that the central bank should not leave a rate hike until it's "too late."
The prospect of higher interest rates in the Eurozone is an interesting one in that the discussion has for so long been about the timing of the next cut.
Broadly speaking, higher interest rates command a stronger currency.
Weidmann’s concern is that "in case of unsound fiscal policy, monetary policy could come under pressure to forgo an interest rate increase even though a tightening would be warranted."
The interest rate debate could, therefore, be turning in the Euro’s favour.
It’s not just interest rates that are in focus - quantitative easing - or asset purchases are also under the spotlight.
“Many central banks including the Bank of England have expressed concern about higher inflation in the coming year and this view puts tapering into play,” says Lien.
Recall that the ECB currently buys €80BN worth of corporate and government bonds each month, keeping down bond yields, and the Euro, in the process.
Tapering is the process where by central banks withdraw their monetary support to the economy by stopping quantitative easing.
It is a positive for a currency as tapering tends to push up the yields delivered by that country’s bonds.
In fact, much of the Euro’s recent strength can be attributed to a fall in demand for Eurozone bonds, which in turn pushes up their yield.
And it could prove supportive of the Euro going into the new year.
“Part of the strength can be attributed to the central bank's break in bond buying. In anticipation of lower market liquidity, the ECB announced last month that they would pause bond purchases between December 22nd and January 1st, resuming bond purchases on January 4th. Without the government's hand in the markets, we could see a further rise in Eurozone bond yields and rebound in the Euro,” says Lien.
Looking ahead to the coming year, Lien and her team are looking to sell rallies in the EUR/USD between 1.05 and 1.06.
This should aid the EUR/GBP higher.