The pound has outperformed alongside other European currencies this month benefitting from the significant improvement in investor sentiment towards the region. It has helped to lift cable back up above the 1.3000-level for the first time since last year’s US election.
In contrast, the pound has weakened modestly against the euro lifting EUR/GBP back above the 0.8400-level for the second time this year. The euro is expected to benefit more than the pound from Germany’s plans for looser fiscal policy.
Market participants now expect monetary policies between the ECB and BoE to diverge less going forward which has helped to narrow yield spreads in favour of a stronger euro. At the ECB’s last policy meeting (click here) they left the door open for further modest rate cuts with the policy rate now closer to the neutral estimate put forward by President Lagarde between 1.75% and 2.25%. Based on our assumption that legislation is passed tomorrow to boost fiscal policy in Germany, it will ease pressure on the ECB to lower rates below neutral. The main risk to that view would be a much bigger hit to growth in Europe from President Trump’s upcoming plans for trade tariffs in early April. The UK economy is still expected to be less negatively impacted by tariffs than major euro-zone economies boosting the relative appeal of the pound.
Market attention will now shift to the BoE’s updated outlook for policy today. Ahead of today’s MPC meeting, the UK rate market is still expecting the BoE to stick to the current quarterly pace of rate cuts by delivering the next rate cut in May (19bps of cuts priced in) but there is less confidence over a further rate cut in August (37bps of cuts priced in). It is helping to keep yields in the UK at higher levels than on offer in other major economies providing support for the pound.
Ahead of today’s MPC meeting, UK economic data has been improving with the exception of Friday’s softer UK GDP report for January. Overall it points to strengthening growth momentum since late year. At the same time the slowdown in services inflation and wage growth remains frustratingly slow. It was revealed this morning that private sector wage growth excluding bonuses remained strong at 6.1% 3Mth/YoY in January. It will become even more uncomfortable for the BoE to keep cutting rates heading into the summer when inflation is expected to temporarily pick up towards 4.0%. Overall, we still believe that the pound remains attractive.
