GBP/EUR steadier & looking for footing above 1.18But upside limited by cautious turn in BoE’s stanceUncertainty emerging over short-term rate outlookInflation data, budget, BoE, ECB speeches in focus

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The Pound to Euro exchange rate was dealt a setback last week with the emergence of a cautious inflection in the Bank of England’s (BoE) outlook for the economy and interest rates, although it could be likely to stabilise above the nearby 1.18 level over the coming days.

Sterling slipped further from recent highs against the Euro last week, reaching lows of 1.1829 in the wake of Thursday’s policy decision from the Bank of England, which lifted Bank Rate back to its pre-coronavirus crisis level but noted growing risks to the outlook for inflation and interest rates.

The BoE placed a question mark over the outlook for interest rates in the months ahead when suggesting that surging energy prices and the resulting increase in inflation and squeeze on incomes could ultimately serve as a substitute for increases in Bank Rate during the period ahead.

“In our view, the market has overdone its expectations regarding the quantity of BoE rate hikes this year. Assuming these are pared back and that the energy crisis in Europe does not worsen, EUR/GBP has the potential to creep higher,” says Jane Foley, head of FX strategy at Rabobank.

Above: Pound to Euro rate shown at daily intervals with Fibonacci retracements of April 2021 rally indicating possible areas of medium-term technical support for Sterling. Selected moving-averages indicate possible support and resistances.

Reference rates at publication:

GBP to EUR: 1.1914High street bank rates (indicative): 1.1580 - 1.1600Payment specialist rates (indicative): 1.1831 - 1.1880Find out more about specialist rates and service, hereSet up an exchange rate alert, hereThe BoE has introduced commodity-induced inflation and its impact on incomes as risks to its medium-term outlook for growth and inflation, meaning they could now potentially lead the Monetary Policy Committee to refrain from raising interest rates again at some point in the near future.

With the market having bet heavily that Bank Rate would rise to 2% or more later in 2022, the emerging uncertainty about the outlook for interest rates is something that could continue to have a stifling effect on the Pound during the weeks ahead.

“In contrast, we anticipate the BoE will only raise to 1.25% by the end of 2022, well below the level currently implied by investors,” says Jonathan Petersen, an economist at Capital Economics.

The Pound to Euro exchange rate appeared to draw a bid from the market whenever close to the round number of 1.18 last week, although with appetite for Sterling potentially dampened by the cautious inflection in the BoE’s policy stance, it could struggle to recover by much this week.

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“Our dashboard reveals GBP holds one of the most substantial discounts across the global currencies we track. That said, we think rallies will be brief and prefer to buy EURGBP dips towards 0.83 [Sell GBP/EUR rallies toward 1.2048],” says Mark McCormick, global head of FX strategy at TD Securities.

“A range of factors (BoE repricing, higher oil, rising stagflation risks, diverging monpol and growth expectations) point to a deteriorating backdrop and underperformance against the likes of USD and EUR,” McCormick also warned in a Thursday research note.

The highlight of the week ahead for the Pound will be Wednesday’s participation by Governor Andrew Bailey in a panel discussion titled Emerging Challenges for Central Bank Governors in a Digital World, at the Bank for International Settlements Innovation Summit.

However, before then Sterling could potentially prove less sensitive than usual to Wednesday’s inflation figures for last month, given emerging uncertainty about whether and how soon Bank Rate could rise again.

Above: Pound to Euro rate shown at weekly intervals with Fibonacci retracements of March 2020 recovery and selected moving-averages indicating possible areas of medium-term technical support for Sterling.

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“Our view that the MPC will be far more passive in the second half of this year than markets expect suggests that sterling’s recent depreciation has further to run,” says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

February’s inflation figures and remarks from Andrew Bailey are the highlights for Sterling but Wednesday also sees HM Treasury announce its latest budget update, which will also likely be scrutinised closely by the market.

“There is now a higher hurdle for the GBP to strengthen more notably in the week ahead if there is another material upside inflation surprise in light of the BoE’s increased focus on downside risks to growth from higher inflation,” says Lee Hardman, a currency analyst at MUFG.

“The UK government is set to present their latest budget statement in the week ahead. Chancellor Sunak is under pressure to announce additional fiscal easing measures to provide support for households who are experiencing the worst cost of living crisis for decades,” Hardman said on Friday.

Meanwhile, the Euro is also likely to pay close attention to the latest IHS Markit PMI surveys for the Eurozone and European Central Bank President Christine Lagarde, who’s scheduled to speak publicly on multiple occasions throughout the week.