EUR/GBP consolidates in 0.8450 area after hitting fresh annual highs as traders weigh ECB/BoE policy divergence

EUR/GBP hit fresh annual highs in the 0.8470s on Friday but has since pulled back to consolidate around the 0.8450 area, where it trades broadly flat on the session. The latest remarks from ECB President Christine Lagarde before the EU parliament did not add anything new to her remarks in last week’s post-ECB meeting press conference. Recall that, last Thursday, her refusal to reiterate a prior statement that rate hikes in 2022 are unlikely and greater emphasis on upside inflation risks triggered a lurch higher in EUR/GBP from fresh multi-year lows under 0.8300.

Last week also saw the BoE surprise markets in a hawkish manner, with four out of nine Monetary Policy Committee members unexpectedly voting for a 50bps rate hike (the BoE actually hiked rates to 0.5%, as expected). These calls for a bigger move were rooted in near-term inflation fears, with the bank now expecting headline CPI to surpass 7.0% in April when UK energy regulator Ofgem raises the gas price cap. The BoE’s hawkish surprise, while enough to briefly push EUR/GBP under 0.8300 and towards a test of the late-2019/early-2020 lows in the 0.8280 area, was overridden by the surprise shift in the ECB’s stance.

The end result was that EUR/GBP enjoyed its best week since April 2021, rallying more than 1.7% to current levels in the mid-0.8400s. As traders reassess their expectations as to the outlook for BoE/ECB policy divergence, some think EUR/GBP could yet be headed higher. In Q2, the UK faces a cost of living crisis with taxes and energy costs set to rise in tandem, factors which likely help keep the BoE’s terminal interest rate capped relative to elsewhere in the G10.

Meanwhile, if over the same time period the Eurozone continues to face hotter than expected inflation, the likelihood that the ECB accelerates its QE taper and signals a Q4 rate hike are high. That could continue to support EUR/GBP in the medium-term, perhaps facilitating a test of the next key resistance are around 0.8600.

In the short-term, analysts flagged a risk of some euro profit-taking after last week’s big moves, especially if ECB policymakers attempt to push back against excessively hawkish money market pricing. Lagarde’s measures comments on Monday certainly don’t suggest further short-term bullish impetus, and a speech from dovish ECB Chief Economist Philip Lane later in the week will also be of note. Any short-term pullback in EUR/GBP may find support in the 0.8420s in the form of the January highs.