ECB’s shifting stance seen weighing on GBP/EURWith conditional policy normalisation in progressCould prompt dip below 1.17, TD Securities says

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The Pound to Euro exchange rate dipped briefly below 1.19 for a third time this week on Friday while strategists at TD Securities are looking for it to slip further over the coming weeks and have become more confident in this idea since Thursday’s European Central Bank (ECB) policy decision.

Pound Sterling was higher against many major currencies during the final session of the week but struggled to make headway against the Euro after the ECB set out on Thursday the further “conditional” steps it could take along the path to monetary policy normalisation during the months ahead.

This is something that potentially puts a floor underneath many European exchange rates, most of which had already been falling heavily for months even before the Russian military crossed into Ukraine in February, triggering in the process a steep sell-off in European currencies.

“For now, we think EURUSD holds the 1.12 resistance, validating the new range of 1.08-1.12. That said, we see more significant downside risks to GBPUSD, reinforcing EURGBP support in the weeks ahead,” says Mark McCormick, global head of FX strategy at TD Securities.

Above: Pound to Euro exchange rate shown at daily intervals with selected moving-averages.

Reference rates at publication:

GBP to EUR: 1.1900High street bank rates (indicative): 1.1585 - 1.1670Payment specialist rates (indicative): 1.1820 - 1.1842Find out more about specialist rates and service, hereSet up an exchange rate alert, here“As we showed in our long EURGBP recommendation, growth, terminal rates, and the yield curve point EURGBP higher. However, we don't think the ECB's gentle transition to "normal" offers much more EURUSD upside in the very short run, with the Fed likely to commence lift-off next week,” McCormick also said when writing in a Thursday research briefing.

TD Securities cites a range of factors for thinking that Sterling could be liable to slip as far as 1.1627 against the Euro over the coming weeks.

These include the relative scale of surprises in recent UK and Eurozone inflation figures as well as the difference between where financial markets expect ECB and Bank of England (BoE) interest rates to end up at the other end of the current monetary policy cycle

While only one of the various indicators, the below graph indicates that a more appropriate level for GBP/EUR would be around 1.1695 and mainly for reasons that are being driven mainly by the ECB’s shifting monetary policy stance.

Source: TD Securities. Click image for closer inspection

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Thursday’s policy decision saw the ECB bring forward to June, from October, the date at which its Asset Purchase Programme would reduce its monthly government bond purchases to €20BN and formally acknowledged that its interest rates could rise in the near future.

Borrowing costs will not rise until “some time after” the Asset Purchase Programme is ended in its entirety, however, and the timing of this step was not specified on Thursday when the ECB emphasised that everything depends on how the Eurozone economy fares in the months ahead.

“If the data - which are critically important because we are data dependent in our decisions - do not support this medium-term outlook as we see it now then we indicate very clearly in our monetary policy statement that I have just read that the governing council stands ready to revise both in terms of timeline and in terms of volume, its purchases. So it is a conditional provision,” President Christine Lagarde said at Thursday’s press conference.

“This is in line with our December meeting, with our February meeting and press conference, and what we are doing is confirming our step-by-step approach, our maximum optionalities in the face of maximum uncertainty, but also delivering on our mandate which is price stability,” she added.

Source: TD Securities.

This all came after Eurostat figures showed inflation accelerating to 5.8% in February, leaving it sitting above the 5.4% seen in the UK during January and all the while recent increases in oil, gas and agricultural commodity prices are threatening to lift it further up ahead.

Those inflation developments prompted the ECB to announce steep upgrades to its forecasts on Thursday to a level where they now envisage the annual inflation rate averaging 1.9% in 2024, which means that for the first time in years the ECB has within its sights an opportunity to sustainably meet its symmetric medium-term target of two percent annual inflation; which has been stated as a precondition for any increase in interest rates.

“With this in mind, it now will take very little to nudge the 2024 inflation forecast to 2.0%, which green-lights a rate hike. But first, the APP must end. Here we now expect an announcement at the July ECB meeting that the programme will conclude at the end of that month,” says Jame Rossiter, global head of macro strategy at TD Securities.

“Data at that time is likely to show euro area headline inflation running around 7% y/y (and we see little downward momentum in the months following). In line with today's new guidance that rate hikes will take place "some time after" the end of the APP, we leave our forecast for a 25bps rate hike in December unchanged,” Rossiter said on Thursday.