EUR/GBP slips to near 0.8700 due to BoE caution, Ukraine tensions

EUR/GBP weakens as the Pound Sterling holds steady amid caution over the BoE policy outlook.
Traders adopt caution as uncertainty surrounding the Ukraine–Russia peace process resurfaces.
The Euro could find support as signals suggest the ECB’s rate-cutting cycle has ended.

Akhtar Faruqui FXStreet

EUR/GBP extends its losses for the second successive session, trading around 0.8710 during the European hours on Tuesday. Volumes are expected to be thin due to the year-end holiday. Traders are also monitoring geopolitical tensions as uncertainty over the Ukraine-Russia peace process resurfaced. Russia’s foreign minister said Moscow’s negotiating stance would shift following alleged strikes on President Vladimir Putin’s residence.

The EUR/GBP cross faces challenges as the Pound Sterling (GBP) remains steady on a cautious tone surrounding the Bank of England’s (BoE) policy outlook. While UK inflation cooled to 3.2% in November, it remains well above the BoE’s 2% target. UK GDP expanded by 0.1% in the third quarter, meeting expectations, but the BoE projects flat growth in the final quarter.

BoE Governor Andrew Bailey signaled that interest rates are expected to ease further in a gradual manner, but cautioned that the scope for additional cuts is limited as rates approach their neutral level. Any moves beyond the latest cut are likely to be finely balanced and strongly driven by incoming data. The BoE lowered the policy rate by 25 bps to 3.75% in December, with a close 5–4 vote highlighting persistent inflation concerns.

However, the downside of the EUR/GBP cross could be limited as the Euro (EUR) could receive support on cautious sentiment surrounding the European Central Bank (ECB) policy outlook. The ECB held rates steady in December and signaled they are likely to remain unchanged for some time, with President Christine Lagarde noting that elevated uncertainty makes forward guidance on future rate moves difficult.

Central banks FAQs

What does a central bank do?

Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.

What does a central bank do when inflation undershoots or overshoots its projected target?

A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.

Who decides on monetary policy and interest rates?

A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.

Is there a president or head of a central bank?

Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.

Author

Akhtar Faruqui

FXStreet

Akhtar Faruqui is a Forex Analyst based in New Delhi, India. With a keen eye for market trends and a passion for dissecting complex financial dynamics, he is dedicated to delivering accurate and insightful Forex news and analysis.

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