The pound hit a pre-coronavirus pandemic high against the euro of 1.1815 during intraday trading on 9 August, its highest level since late February 2020. This was largely thanks to the Bank of England (BoE) setting out plans for modest tightening of monetary policy at its latest meeting on 5 August.
BoE’s hawkish stance stokes rise in GBP/EUR
In recent weeks, the GBP/EUR exchange rate had been fluctuating between a range of 1.16 and 1.18. Investors had been cautious in the run-up to the meeting, with many believing the BoE will be the first major central bank to raise interest rates, given the strengthening UK economy and rising inflation.
The BoE left interest rates unchanged but signalled that “some modest tightening” of monetary policy may be needed over its three-year forecast period. The monetary policy committee voted seven to one in favour of maintaining the current pace of government bond-buying.
There were warnings that inflation is now expected to rise to 4% by the end of the year, up from the previously forecast 3% rise. A sign of the UK economy’s continued robust recovery.
The BoE also indicated that it might look to raise interest rates next year. The European Central Bank (ECB) had said in its 22 July meeting that it wouldn’t look to increase its interest rates until 2024 or 2025.
Analysts and commentators have described the BoE’s stance as “hawkish”. Although it had largely been expected, the central bank’s recent meeting has reaffirmed the pound’s growing strength.
In a note to clients, strategists at ING Group said it “may be a small step for the BoE, but it is a giant leap compared to ECB communication … with the BoE’s finger now on the trigger, any better UK data could start to see some outsize reaction in GBP as BoE tightening expectations are brought forward,” analysts at the firm added.
Pound strengthens on a buoyant dollar
The pound’s rise against the euro could also get a second wind from the pound falling against the dollar. That’s according to Asmara Jamaleh, an economist at Intesa Sanpaolo, who was speaking to Pound Sterling Live following the BoE’s meeting.
The GBP/USD rate has been falling since the end of July, but dipped further recently following the latest US jobs report released on 6 August. The unemployment rate dropped from 5.9% in June to 5.4% in July, while 943,000 jobs were added after 938,000 jobs were added in June. This was the biggest monthly rise since August of last year.
If these job market trends continue over the next couple of reports, the Federal Reserve could take action to reduce its quantitative easing programme. As it stands, the Fed is planning to raise interest rates in 2023. The tapering of bond-buying could start sooner than originally expected.
Sterling expected to weaken ahead of Fed’s tapering
“We continue to expect a weakening of the pound in the run-up to the Fed’s tapering, but smaller than the euro’s, against which sterling should tend to strengthen as a result,” Jamaleh told Pound Sterling Live.
That said, future movement in the GBP/EUR rate is likely to also depend on what happens with the eurozone’s recovery.
Despite a stronger-than-expected second quarter, Chris Hare, an HSBC economist, told The Telegraph that he’s concerned the region’s growth may have peaked or hit a lull at the very least.
If the UK’s growth rate outpaces those of countries in the eurozone in the months ahead, then this narrative could help the pound to continue pushing higher against the euro.
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