Pill says more rate hikes comingGoldman Sachs says this will support GBPBut MUFG says GBP/EUR's highs are in the past

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The Bank of England will continue pushing interest rates higher according to its Chief Economist, a development that signals to strategists at Goldman Sachs that further upside impetus for the British Pound is possible.

Bank of England Chief Economist Huw Pill said in a speech on Wednesday February 09 that he voted to hike Bank Rate by 25 basis points on February 03 but he was minded to join colleagues and deliver an even larger 50 basis point hike.

He said recent labour market and wage data supported the prospect of further rate hikes and he remains committed to a steady, data-dependent reaction to price inflation.

"Last week's Bank of England meeting sent an emphatic, if somewhat surprising, message - the Committee feels it is necessary to make policy more restrictive in order to cut off a potential wage-inflation spiral," says Zach Pandl, a foreign exchange strategist at Goldman Sachs.

The Bank of England's economists in February revised up forecasts for underlying wage growth in 2022 to rates approaching 5%.

"Given expected productivity developments, this rate is probably stronger than that consistent with the inflation target over the medium term," said Pill in a speech to the Society of Professional Economists, validating expectations for further rate hikes.

"Following the market-implied path to 1.2% by the end of this year would have left inflation somewhat below target. I leave it to you to draw any implications for where the MPC sees the path of Bank Rate headed," says Pill.

Goldman Sachs' Pandl says for foreign exchange markets the question becomes whether raising interest rates is good or bad for the UK currency.

On the one hand higher rates could slow economic growth, adding headwinds just as consumers suffer elevated inflationary pressures.

On the other, higher rates beget a stronger currency as bond yields rise, which in turn attracts foreign investor capital.

Above: The rise in ten-year bond yield is built on expectations for higher UK interest rates. This is a potent source of support for GBP. Above GBP/EUR at daily intervals.

Reference rates at publication:

Pound to Euro: 1.1848 \ Pound to Dollar: 1.3534High street bank rates (indicative): 1.1616 \ 1.3255Payment specialist rates (indicative): 1.1789 \ 1.3466Get a market-beating rate quote, hereSet up an exchange rate alert, here"In FX, questions have again turned to whether this is positive or negative for the currency given the negative growth implications but higher policy rates," says Pandl.

"We feel strongly that it should be a positive, all else equal," he adds.

Goldman Sachs' modelling finds higher rates outweigh the impact from weaker growth, particularly when it is assumed the Bank of England will tighten more than its peers, especially the ECB, for a given inflationary shock.

"While the ECB delivered a larger surprise relative to expectations, we are reluctant to lean into recent Sterling bearishness, and would see EUR/GBP as a good target if ECB policymakers take a slower approach to normalization than we now expect," says Pandl.

But Lee Hardman, Currency Analyst at MUFG, says the Pound has put in its highs against the Euro in the current cycle.

"The EUR has strengthened sharply over the past week both in the run up to and following the ECB’s latest policy update," says Hardman in a note.

He says last week saw the EUR had its best weekly performance against an equally-weighted basket of the GBP and USD since early March 2020.

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"The price action is threatening to bring an end to the bearish trend that has been in place for the EUR since the start of last year," says Hardman.

The European Central Bank surprised investors by essentially calling an end to an era of persistently low interest rates, validating expectations that a rate hike could come as soon as the second half of 2022.

"The latest ECB policy meeting could prove to be an important pivot point for the EUR," says Hardman.

As a result, MUFG are more confident now that the lows are in place against the USD and GBP at 1.1121 and 0.8285 respectively. (Pound to Euro rate high at 1.2070).

"Furthermore, we see room for EUR strength to extend further in the near-term," adds Hardman.

Strategists at Danske Bank say the Pound-Euro rate has topped as the ECB policy will turn more hawkish than that of the Bank of England on a relative basis.

Danske Bank's Chief Analyst Mikael Olai Milhøj says he is of the view that the level of around 1.2050 was the top for the exchange rate (bottom at 0.83 for EUR/GBP.

"Relative rates now seem more supportive for EUR than GBP, as BoE rate hikes are already priced in and the ECB is turning more hawkish," says Milhøj.

But don't expect a major decline in Sterling as Danske Bank still sees the 2022 investment environment as USD-positive, which they say is usually benefitting of the Pound relative to the Euro.

"Hence, we continue targeting EUR/GBP at 0.84 in 12M," says Milhøj. (1.19 in GBP/EUR).