The economies of the UK and the Euro Area have taken diverging paths since the start of the year, allowing the GBPEUR to continue to appreciate. The latest leading indicators suggest the divide has deepened, and this has given the GBPEUR pair a new wind. But, the question that most traders are interested in is: Will this continue.
It’s particularly relevant given the discussions being carried out at the ECB, with considerable doubt around the future rate path. Meanwhile, it seems like the BOE’s hands are somewhat tied in the short term. Could a more detailed analysis give a better look at where the two currencies are headed?
The Pattern Emerges
Not surprisingly, what’s driving the currencies is differences in economic performance between the UK and Europe. It started at the end of last year, when the UK fell into a technical recession while the Euro Area managed to escape it by the bare minimum. Since then, the British economy has been growing (having a slightly lower base to rebound from), while the Euro Area keeps staying mired in stagnation.
Faster economic activity means more monetary circulation and more inflationary pressure. As a result, the BOE has had to take a much more cautious approach to easing. Both the BOE and the ECB have cut rates one time so far. But the BOE is starting from a much higher level than the shared central bank. Even though that means it has more potential downside, for now the higher interest rates make the pound much more attractive.
The Pattern Deepens
The trend got a boost at the start of this week when UK PMIs were not only in expansion, but showed persistent price pressures. Meanwhile, Euro Area PMIs were in construction, and the flash reading of CPI fell to 1.8%, below the ECB’s target. The core rate remains well above target, but the ECB is not mandated to track the core rate. Just the long-term inflation rate.
That has fueled speculation that the ECB doves will have more ammunition to make the case for rate cuts at the October meeting. But across the English Channel, while the heads of the central bank talk about easing, they are still data dependent. And the data is pointing to a still resilient (if somewhat softening) economy despite the near decades high interest rates.
Can This Continue
Europe’s economy is forecast to rebound next year, but continue to remain slow for the coming months. Part of the expected economic rebound relies on expectations for the ECB to cut rates in order to juice the economy. Which is negative for the Euro. For the short term, in other words, barring a surprise recovery of the shared economy, the shared currency is on a downward tack.
Britain is also expected to see its economy slow down. But, part of that is a lack of confidence in the new administration to not put up roadblocks for business, particularly the issue of taxes. Higher taxes typically result in higher inflation, which means that even if the UK economy slows, it will likely be in tune with measures that would keep the BOE from cutting so fast. Barring some unforeseen circumstance that causes the UK economy to suddenly turn down, the pound could remain elevated for the next couple of months.
