The Pound to Euro exchange rate (GBP/EUR) reached its highest level since November 2012 yesterday as speculation as to when the Bank of England will start normalising monetary policy continued to drive investors into UK government bonds.
Yesterday’s 1.5-year high GBP/EUR spike marked the seventh consecutive day that the currency pair has rallied to a fresh yearly high. The single currency’s depreciation begun at the beginning of the month when the European Central Bank cut the benchmark interest rate to 0.15% and brought the deposit rate down into the negative territory at -0.10%. Plans to stop sterilising Eurozone bonds purchased as part of the SMP programme as well as a new €400 billion liquidity boost also compromised demand for the Euro.
Of the ECB’s latest stimulus measures it seems that the deposit rate cut has had the largest impact on the single currency. This is because traders at commercial banks in Europe have started investing heavily in Eurozone bond yields to avoid being charged -0.10% by the ECB. This scenario has driven bond yields down to ludicrously low prices – should Spanish debt really carry less of an incentive to purchase than bonds issued by the world’s largest economy (the US)? – which in turn has dampened foreign investors’ appetite for Eurozone bonds.
Despite the ECB’s latest accommodative stimulus measures inflation in the currency bloc – currently running at a joint-4-year low of 0.50% – is unlikely to pickup any time soon and growth in the region’s second largest economy (France) looks harder to come by than an investor who is betting against further GBP/EUR strength. This makes it increasingly likely that the ECB will look to stave off the threat of deflation once and for all with an unprecedented and expansive sovereign bond-buying programme. The threat of quantitative easing in the 18-nation bloc is another factor that is pushing Sterling higher against the Euro.
Last week UK unemployment fell to a 5-year low of 6.6% and BoE Governor Mark Carney cautioned businesses and consumers in Britain that interest rates were likely to rise before the end of the year. Carney’s speech sent GBP/EUR skyrocketing through resistance levels and the Pound is currently trading above 1.2500 against the single currency.
The profound contrast in central bank outlooks – hawkish rhetoric from the Bank of England and dovish policy from the European Central Bank – means that Sterling is likely to push GBP/EUR higher over the next few weeks and months.
The Pound to Euro exchange rate struck a multi-year high of 1.2892 in July 2012 and it is possible that GBP/EUR could rise towards that level again over the next few months if monetary policy expectations continue to support Sterling strength over and single currency weakness.
Euro Exchange Rate Forecast – 18/05/14
The Euro remains under pressure and is forecast to soften further against the Pound and give up its small gains against the US Dollar as investors expect that today’s Bank of England policy meeting minutes for June and tonight’s Federal Reserve policy meeting will show that the UK and US economies are diverging from that of the Eurozone. The Fed is expected to cut its asset purchase program by another $10 billion, but is not expected to raise borrowing costs until mid-2015.
Whilst the ECB cuts rates the BoE and Fed are considering raising them. Today’s construction output data is also likely to disappoint, adding to concerns from weak inflation figures published earlier in the week. The Euro also remains vulnerable to concerns over the ongoing conflict in Ukraine and the mounting violence being seen in Iraq.
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