GBP-EUR Exchange Rate Recovers From 10-week Low in August
Markets braced for the Bank of England’s (BoE) latest interest rate decision at the start of August. The pound initially crashed after the UK central bank delivered its 14th consecutive rate hike.
While interest rates were lifted to 5.25%, in line with market expectations, as the BoE continues to battle inflation, the reaction was negative – causing the pound to fall to a near five-week low in the 1.15 mid-range against the euro.
The UK currency soon rebounded above 1.16 following BoE Governor Andrew Bailey’s accompanying comments. While stopping short of committing to more hikes, he left the door open to further tightening by iterating that borrowing costs need to stay “sufficiently restrictive for sufficiently long” – a moderately hawkish stance that poured cold on potential rate cuts.
The GBP-EUR pair ceded the ground it had regained after the euro benefitted from a weakening US dollar, which was dented by news that the US created fewer jobs than forecast in July.
The pound was given a brief respite by comments from the BoE’s chief economist, Huw Pill, who stated that central bank rate-setters are committed to achieving its 2% inflation target – raising expectations that further hawkish action is in the offing to cool inflation.
Bleak forecasts for the UK economy soon undermined the UK currency. Downbeat assessments from The National Institute of Economic and Social Research (NIESR) suggested that the economy will have lost five years’ worth of growth and is expected to enter recession.
This was compounded by the euro’s negative correlation with the safe-haven dollar as the market mood shifted away from risk-averse trade, allowing the single currency to strengthen against the pound.
Having crumbled to a 10-week low just above the 1.15 benchmark on 11 August, the GBP-EUR pair rallied amid upbeat GDP data that confirmed the UK economy avoided a Q2 recession and grew more than anticipated – stoking expectations of additional rate hikes.
Meanwhile, hotter-than-expected PPI data supported the dollar, which weighed on the euro.
The pound briefly wavered against the single currency following mixed UK jobs data that showed a cooling labour market. Meanwhile, the euro benefitted from moderate support after the latest ZEW economic sentiment readings pointed to a modest improvement in confidence across the single bloc.
The UK currency began to shift through the gears again, cruising just above the 1.17 level – a one-month high against the euro – thanks to July’s CPI print on 16 August, which reported headline inflation eased sharply from 7.9% to 6.8% as expected.
The pound’s bull run was derailed by ongoing concerns over the UK economy, which offset further tightening expectations from the BoE in the face of persistently sticky inflation.
British retail sales shrank an eyewatering 1.2% in July, far worse than the forecast 0.5% contraction amid unseasonably wet weather, putting the pound under more pressure.
The GBP-EUR pair meandered between the upper reaches of 1.16 and the 1.17 basement against a backdrop of BoE policy tightening expectations and disagreement between members of the European Central Bank relating to potential hikes in the single bloc. Their diverging views were prompted by producer price inflation figures from Germany, which fell by more than expected in the year to July.
The pair briefly spiked to a one-year high on 23 August before slumping to a one-week low after UK business activity unexpectedly contracted. The volatility occurred in the wake of the latest PMI surveys on both sides of the English Channel.
The latest Eurozone results dragged the single currency lower after revealing a deepening contraction in private-sector activity. However, the UK print was even worse, dragging the pound down. Most concerningly, the powerhouse services sector entered contraction territory for the first time since January. The downbeat data revived UK recession fears, while also dampening BoE rate hike bets.
The pound continued to tumble as economists predicted UK interest rates to peak at 5.5% in September after the alarming PMI data exacerbated fears over the UK economy’s vulnerability.
The GBP-EUR pair managed to apply the brakes to its slide ahead of the bank holiday weekend after the Ifo Business Climate Index for Germany – Europe’s largest economy – declined for the fourth consecutive month.
This was offset by a hawkish speech from ECB President Christine Lagarde who reiterated the need to bring inflation back to 2%, buoying euro investors.
The pound was on the back foot against the euro again towards the end of August after its tentative rally stalled amid the worsening UK economic outlook. This was illustrated by the latest British Retail Consortium (BRC) data, which recorded a slowdown in shop-price inflation to 6.9% for August from 7.6% previously – the lowest reading for 10 months.
GBPEUR: 3-Month Chart
The BoE is widely expected to hike interest rates by a quarter of a percentage point on 21 September, lifting borrowing costs from 5.25% to 5.5%.
Influential data from the UK economy in September: BoE Monetary Policy Report Hearings (7 September), ILO Unemployment Rate (12 September), Retail Sales (15 September), Consumer Price Index (20 September), S&P Global/CIPS Composite PMI (22 September), GDP (29 September).
The ECB announces its next monetary policy decision on 14 September, with a rate hike remaining on a knife-edge.