Bloomberg: Pound may lag behind euro because of policy divergence between central banks

Source: Bloomberg

Author: Naomi Tajitsu

Article: Original Article

Publication date: Tuesday, December 20, 2022 

This year, the pound depreciated against the euro and risks falling again in 2023. 

The British currency is suppressed by the Bank of England, which has become more concerned about the further increase in interest rates, while the European Central Bank amps up its rhetoric on the need for additional steps to curb inflation. Analysts, including the Royal Bank of Canada and Bank of New York Mellon, think that the euro will appreciate against the pound. 

This trade is based on the key theme — divergence in monetary policy. Traders watch which politicians are first to get scared by aggressive rate hikes in the whole world this year. 

“This is a constant subject, mispricing of rate expectations — and the euro exchange rate could be the most remarkable example”, said Adam Cole, head of currency strategy at RBC. He expects that by the end of 2023, the EURGBP pair will reach 0,90 — a level that last time was seen during the chaos of UK financial markets at the end of September.

While the consensus in a Bloomberg survey implies the rise of EURGBP only to 0.89, Commerzbank AG and TD Securities forecast that 0.90 will be reached by June. The sentiment reversed against the pound after the final meeting of the Bank of England last week.   

The Bank of England and ECB increased the interest rates by 0.5%, but in the first case, two voting members asked not to introduce the policy changes, while the ECB decision was followed by a chorus of politicians, saying that the rates should grow even more. Last week, it made the euro grow by 1.4%, and the monthly high against the pound was reached. 

“EURGBP is probably the best way to play this game”, says Geoff Yu, senior currency strategist at Bank of New York Mellon, adding that the Bank of England won’t increase the rates as much as it is currently priced in the market.

According to Lee Hardman, currency strategist at MUFG, the ongoing rate hike of the Fed and ECB also increase the chances of a harder landing for the world economy, and this will hurt the riskier assets like the pound. 

“I could be sure that the euro outperforms other currencies with higher risk, including the pound”, said Hardman. 

Forecast: growth of EURGBP