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The Pound to Euro exchange rate fell to 19-month lows last week in what was its largest five-day decline since September 2022, however, the pair could stabilise in the days ahead and may even have scope for a partial rebound if the latest UK inflation figures help the Sterling bond market onto a better footing.
GBP/EUR unravelled last week amid a parabolic rally by the Euro and a rout in Dollar rates, as well as in US stock and bond markets, that saw the currencies of current account surplus jurisdictions like the Euro Area, Switzerland and Japan surge in gains ranging from 2% to more than 5% against the greenback for the week.
“The USD remains very heavy and it feels like it is now taking on a life of its own as it ignores gyrations in other asset classes and correlations, which smacks of large allocation shifts. It is very hard to think of a headline that will turn this around as further US policy flip flopping will only exacerbate the problem,” says Laoise Ni Thighearnaigh, a trader on the FX desk at JPMorgan, in a Friday commentary.
“For EURGBP we are challenging 1.15 in GBPEUR as we speak, having had a brief blip through overnight. I have trimmed some [of my short GBP, long EUR position] here as it was my stretch target but just have to keep something so I am sticking with a core. Next level is 0.8765 [1.1409 in GBP/EUR],” she adds.
Above: GBP/EUR shown at daily intervals alongside ICE US Dollar Index. Fibonacci retracements highlight possible areas of technical resistance. Click for closer inspection.
The trade conflict between the US and China has been the dominant driver of the US Dollar sell-off and Euro rally, which has been less beneficial for the Pound because of the concurrent weakness in a US Treasury market that often appears to have a significant influence over the Sterling Gilt market.
British Gilts fell across the curve, leading the cost of financing and refinancing for the taxpayer to rise on Wednesday and Friday last week amid similar price action in US Treasuries, which might have been more a symptom of FX interventions aimed at tempering the decline of the Chinese Renminbi than anything else.
Hence why Sterling could have scope to stabilise and perhaps even attempt a partial recovery this week if Wednesday’s inflation figures help the bond market back onto a better footing. However, the Pound to Euro rate might also benefit from Thursday’s European Central Bank policy decision.
“A rising Euro will add to the woes of European industry as it faces tariff and defence spending pressure from the USA, the loss of Russian energy supplies and China’s switch from customer to competitor,” says Benjamin Picton, a strategist at Rabobank, in a Monday market commentary.
Above: Pound to Euro rate at weekly intervals with Fibonacci retracements of September 2022 recovery indicating possible areas of technical support. Click for closer inspection.
“Despite Europe’s Byzantine political system and ongoing competitiveness problems, it appears that some traders at least are interpreting sclerosis as stability and marking Europe up for the fiscal headroom enjoyed by the likes of Germany and the Netherlands,” he adds.
Capital repatriation by investors from current account surplus countries and the broad-based losses of the Chinese Renminbi have weighed heavily on the US Dollar and placed the trade-weighted Euro on an upward trajectory at a time when commercial competitiveness is a top concern for European policymakers.
The Euro’s gains will also reduce inflation in the Euro Area and likely lead the ECB to adopt a more dovish policy stance, which could temper the rally in EUR/USD - if not lead to a temporary setback - and is another reason why simultaneous rallies in EUR/GBP and EUR/USD might be unsustainable beyond the short-term.
“The hit to growth from reciprocal tariffs, uncertainty and financial conditions likely exceeds what the ECB was expecting,” says Mark Wall, chief economist at Deutsche Bank. “Higher FX, lower oil prices and greater risk of trade diversion are skewing the inflation risks to the downside.”