GBP/EUR struggling for momentum beyond 1.2000But well supported above major average at 1.1893Uncertain BoE rate outlook a short-term constraintEurope’s energy headwinds supporting GBP/EURMarket optimism on Ukraine talks a downside risk

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The Pound to Euro exchange rate has rebounded swiftly from its mid month sell-off but struggled last week to extend the recovery much beyond 1.2050 and ebbing momentum now risks sidelining Sterling into a consolidation beneath its earlier highs.

Sterling rose more than one percent against the Euro last week to trade as high as 1.2055 in what was a noisy period of price action for many currencies, although it was unable to sustain the recovery back above the 1.20 handle.

While rising oil and gas prices had taken a fresh toll on the Euro and placed a floor underneath GBP/EUR by the Friday close, Sterling eased lower from Wednesday onward even after February’s inflation figures surprised on the upside of market expectations.

“EUR/GBP has climbed back to the middle of the 0.83-0.84 range after having failed to decisively break below the 0.8300 support [GBP/EUR above 1.2048 resistance] earlier this week,” says Francesco Pesole, a strategist at ING.

“Still, the euro’s higher exposure to Russia-related and commodity-related risks warrants a break below the 0.8300 level in the near term [GBP/EUR above 1.2048}, in our view,” Pesole and colleagues said on Friday.

Above: Pound to Euro exchange rate shown at daily intervals with selected daily moving-averages. Click image for closer inspection.

Last week’s retreat may have been symptomatic of emerging uncertainty about the Bank of England (BoE) interest rate outlook that could act as an ongoing headwind for Sterling, and may ultimately see GBP/EUR struggling to sustain itself above 1.20 without a further leg lower from the Euro.

“If the market unwinds its expectations regarding central bank tightening in the UK, GBP will be vulnerable. It is our central view that EUR/GBP can push higher into the middle of the year and beyond,” says Jane Foley, head of FX strategy at Rabobank.

“That said, this view is caveated around the outlook that the Eurozone will avoid energy blackouts and stagflation. Our 3 month EUR/GBP forecast stands at 0.84 [GBP/EUR 1.1904},” Foley said in a review of Rabobank’s forecasts for Sterling last Wednesday.

The BoE said in its March policy decision that surging energy costs are likely to squeeze the economy and reduce domestically generated inflation in the years ahead, potentially making them a substitute for some of the interest rate rises the bank had previously suggested are likely to be seen up ahead.

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“Rate hikes may win out in the near-term but the communication around these hikes as well as the quantum will be impacted by the evolving macro and geopolitical story,” says Kamal Sharma, an FX strategist at BofA Global Research, who sees GBP/EUR slipping to 1.1764 over the coming months.

February’s forecasts suggested Bank Rate would likely rise to 1.5% by the early months of 2023 and only the next round of projections due out in May could tell how much the BoE’s outlook has been impaired by the Russian invasion of Ukraine, and its knock-on effects for energy costs and inflation.

The question mark over the outlook for Bank Rate is a risk for Sterling as the May month comes around, although for now many analysts still expect the Pound-Euro rate to benefit from the BoE’s proactivity relative to the European Central Bank (ECB), as well as from other Euro vulnerabilities.

“In the near term, we expect the GBP to outperform its European G10 FX peers but underperform G10 commodity currencies. Among the G10 energy importers, the UK is the most energy self-sufficient. It produces 71% of its primary energy consumption needs, compared with only 21% for the eurozone,” says Eimear Daly, an FX strategist at Barclays, who tips Sterling to remain close to 1.2048 over the coming months.

Above: Pound to Euro exchange rate shown at monthly intervals with Fibonacci retracements of late 2015 and June 2016 falls indicating various areas of long-term technical resistance for Sterling. Click image for closer inspection.

“The UK also has more limited direct exposure to Russia. Over 80% of the UK’s natural gas imports come from Norway, with only 15% from Russia. While the UK will still be affected by the energy price shock, it does not face the same magnitude as its European peers and, thus, should outperform the EUR, SEK and DKK in the near term,” Daly and colleagues said in a review of Barclays’ forecasts for Sterling last week.

Europe’s greater reliance on Russian oil and gas means the invasion of Ukraine could be more inflationary for the Euro area and a greater economic headwind, hence why the conflict has taken a larger toll on the single currency.

This means the Euro will likely be sensitive to the outcome of negotiations between Russia and Ukraine, which resume in Turkey on Monday and run through Wednesday but would act as a headwind headwind for the Pound to Euro rate if they result in any progress toward a ceasefire agreement or resolution of the conflict.

Meanwhile, Monday and Wednesday speeches from BoE Governor Andrew Bailey and Deputy Governor Ben Broadbent will be listened to closely in light of recent questions about the market's assumptions for Bank Rate in the coming months.