GBP/EUR benefits from strong support at 1.1290 & 1.1274Hawkish ECB a headwind but valuation turning supportiveInflation differential suggests 'fair value' at 1.1667 & aboveBut market bearish on GBP/EUR outlook as EZ CPI looms

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The Pound to Euro exchange rate entered the New Year well supported near 1.13 but facing headwinds from a hawkish European Central Bank (ECB) and the prospect of an imminent decline in Euro area inflation that could lean against any attempted recovery by a currently-cheap Sterling up ahead.

Sterling held for a sixth day on Monday above two notable technical support levels located around 1.1290 and 1.1274 on the charts against the Euro in a further tentative sign of the mid-December sell-off in GBP/EUR having run its course.

The Pound had been trading comfortably around 1.1650 in December when a hawkish ECB prompted financial markets to bet on a steeper climb for European interest rates up ahead, leading the Euro to rise and Sterling to fall as low as 1.1271 by last week.

Using the latest inflation and Bank Rate differentials to deflate from a January 2022 starting level around 1.1928 suggests GBP/EUR is cheap while trading below 1.1677, though Sterling faces multiple headwinds to any recovery including the prospect of a fall in Euro area inflation this Friday.

"We have revised our forecasts for GDP and CPI inflation only marginally, and left our Bank Rate projection unchanged, since our previous Forecast Review at the start of December," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

Above: Pound to Euro rate shown at daily intervals with Fibonacci retracements of late September recovery indicating possible areas of technical support for Sterling. Click image for closer inspection.

"We doubt GDP will start to recover until Q1 2024. December, however, wasn’t all doom and gloom. Encouragingly, CPI inflation fell to 10.7% in November, from 11.1% in October, undershooting the MPC’s 10.9% forecast," Tombs writes in a Monday research briefing.

Gloomy expectations for the UK economy have been a prominent dampener of market appetite for Sterling in recent months though it's an outperforming single currency and the prospect of a fall in European inflation when the December data is released on Friday that is posing risk to GBP/EUR this week.

Consensus suggests Europe's inflation rate fell from 10.1% to 10% in December, making for a second consecutive decline from a 10.7% peak in October, though some economists see the inflation rate falling further in what would be a potentially bearish outcome for the Pound to Euro rate on Friday.

"We forecast euro area December flash inflation to print at -0.4% m/m and 9.2% y/y," says Iaroslav Shelepko, an economist at Barclays.

"We highlight a much larger than usual uncertainty related to the treatment of energy subsidy in Germany. We expect core EA inflation at 4.9% y/y in December," Shelepko and colleagues write in Thursday research briefing last week.

Friday's inflation data is the highlight of the week ahead when it comes to UK and European economic data though the Pound to Euro rate will likely also be positively correlated with the ebb and flow of investor appetite for riskier assets as trading activity normalises following the festive break.

Above: Pound to Euro rate shown at weekly intervals with Fibonacci retracements of recovery from September low indicating possible areas of technical support for Sterling. Click image for closer inspection. If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.