Policy Differential between the Central Banks of England & Europe & the Impact on EUR/GBP

  • EURGBP
    (${instrument.percentChange}%)

Rampant Inflation & Stagflation Fears

Both the United Kingdom and Eurozone, are plagued by surging inflation, which gives governments and central banks a headache, as they also have to grapple with the economic fallout of the war in Ukraine and the pandemic.

The UK Consumer Price Index (CPI) skyrocketed to a shocking 9% in April year-over-year, from 7% prior, marking the highest level since the National Statistics began in 1997 and an estimated high since 1982.

In its latest forecasts, the Bank of England (BoE) projected CPI to peak at around 10% in the fourth quarter [1], although previous projections have been surpassed multiple times. In his recent testimony in the House of Commons, BoE governor Bailey had highlighted energy price shocks and food prices as his main concerns, apologizing for been "apocalypric" on the latter [2].

The UK economy grew by 0.8% in the first quarter of the year (quarter-over-quarter) from 1.3% prior, what may turn out to be a high point, since the central bank expects GDP to contract in the last quarter of 2022

The situation around inflation is not good in Eurozone either, since CPI surged to a record 7.4% in April (year-over-year), while this week's preliminary data for May, revealed a jump to 8.1%.

The European economy is exposed to the war in Ukraine and dependent to Russian gas and oil, with EU leaders agreeing this week on a plan to ban most of oil imports from Russia[3], while Eurozone's GDP grew by just 0.3% in Q1 (quarter-over-quarter) according the second reading.

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Bank of England Between a Rock & a Hard Place

The central bank has implemented a front-loaded monetary tightening path in order to combat high inflation, having delivered four straight 25 basis points rate hikes, which is the longest streak since 2007.

This tightening started late-last year, after some communication snafus, while the process has not exactly been a smooth ride, as we have seen disagreements among officials in regards to the size of the moves.

The BoE has refrained from more aggressive half-percentage rate increases, but in the last meeting in May, three members - out of nine – voted against the majority, in favor of such a move [4].

The central bank is in a bit of a bind as rampant inflation warrants more hikes, while economic slowdown and its projection for a contraction, pull in the opposite direction.

The latest forward guidance was a bit vague, as most members of the Committee judged that "some degree of further tightening in monetary policy may still be appropriate in the coming months".

The next policy decision is due on Thursday June 16 and remains to be seen if the Bank of England is ready to act again.

European Central Bank Ready for Lift-off

The central bank has been on the far dovish site of the monetary policy spectrum and way behind its major counterparts, employing negative benchmark interest rates and still running an assets purchases program (APP).

It has been reluctant to change tack since it has to take into account the implications of the war in Ukraine, but high inflation seems to be forcing its hand, as it has been turning more hawkish recently.

After having accelerated the tapering of the APP, the ECB firmed-up its rhetoric in the last meeting in April, saying that it will conclude in the third quarter, while any changes to the interest rates were expected to take place "some time" after that [5].

Recently we have seen a series of officials calling for rates lift-off as early as July, with President Ms Lagarde giving her seal of approval last week.

She now expects the APP to end "very early" in the third quarter, which would allow "a rate lift-off at our meeting in July", adding that the bank will likely be in a position to "exit negative interest rates by the end of the third quarter". [6].

This is an aggressively hawkish U-turn, given that Ms Lagarde had been ruling-out rate hikes in 2022, as recently as February [7].

The European central bank will announce its next policy decision on Thursday June 9 and we will be looking for more hints around its policy intentions.

EUR/GBP Movement

The pair comes from a volatile month, during which it registered its best performance since April 2021 and multi-month highs, as the doom and gloom by the Bank of England sent it higher and the ECB started to get more hawkish.

This shift in expectations around the policy differential between the two central banks was beneficial for the pair, but the question is whether it can carry it further, given that this may now be priced-in.

The common currency failed to benefit from the record preliminary inflation for Eurozone on Tuesday and ended the day pretty much flat and today its down, but runs a profitable week.

Looking at the daily chart, EUR/GBP sits above the 200 and 50 EMAs which points to upside bias, while this could be strengthened, if the converging EMAs form a Golden Cross.

Furthermore, it tries to stay above the 23.6% Fibonacci of the 2020 High/2022 Lows drop, which could open the door to a larger advance towards the 38.2% level (0.8698), with the next major resistance located at mid-0.8800s.

Despite recent solid performance, EUR/GBP has not been able to extend its May highs so far and as long as it fails to break new ground, it is vulnerable to a test of the aforementioned EMAs.

Closes below them, would shift bias to the downside, although new 2022 lows do not seem easy, in the scope of the shifting policy stance.

In any case, the policy updates from the ECB and the BoE over the next two week's will likely impact the pair's trajectory.

Nikos Tzabouras

Senior Market Specialist

Nikos Tzabouras is a graduate of the Department of International & European Economic Studies at the Athens University of Economics and Business. He has a long time presence at FXCM, as he joined the company in 2011. He has served from multiple positions, but specializes in financial market analysis and commentary.

With his educational background in international relations, he emphasizes not only on Technical Analysis but also in Fundamental Analysis and Geopolitics – which have been having increasing impact on financial markets. He has longtime experience in market analysis and as a host of educational trading courses via online and in-person sessions and conferences.

References

1

Retrieved 02 Jun 2022 https://www.bankofengland.co.uk/monetary-policy-report/2022/may-2022

2

Retrieved 02 Jun 2022 https://committees.parliament.uk/oralevidence/10215/pdf/

3

Retrieved 02 Jun 2022 https://twitter.com/eucopresident/status/1531424785464320000

4

Retrieved 02 Jun 2022 https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2022/may-2022

5

Retrieved 02 Jun 2022 https://www.ecb.europa.eu/press/pr/date/2022/html/ecb.mp220414~d1b76520c6.en.html

6

Retrieved 02 Jun 2022 https://www.ecb.europa.eu/press/blog/date/2022/html/ecb.blog220523~1f44a9e916.en.html

7

Retrieved 03 Jul 2022 https://www.ecb.europa.eu/press/pressconf/2022/html/ecb.is220203~ca7001dec0.en.html

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