Euro holds steady against British Pound as ECB, BoE rate hike bets offset each other

EUR/GBP trades around 0.8580 on Thursday at the time of writing, showing little change on the day. The pair lacks a clear direction as both the Euro (EUR) and the British Pound (GBP) benefit from monetary tightening expectations, with investors assessing persistent inflationary pressures in the Eurozone and the United Kingdom (UK).

European economic fundamentals continue to provide some support to the Euro. The sharp rise in European natural gas prices, linked to supply disruptions in the Middle East, is keeping inflation risks elevated and strengthening the case for further interest rate hikes by the European Central Bank (ECB) this year.

The latest German data point in the same direction. Germany’s Producer Price Index (PPI) rose 3% YoY in July, accelerating from the previous month and exceeding market expectations of 2.7%. This marks the fastest annual increase since April 2023. On a monthly basis, producer prices rebound by 1.1%, signaling persistent price pressures in the Eurozone’s largest economy.

Economists at UBS point out that German producer prices have surprised to the upside, noting that “German producer prices were higher than consensus.” However, they downplay the broader significance of the release, observing that “very few economists bother to forecast this data,” suggesting the figures carry limited weight for market participants relative to other drivers.

Against this backdrop, expectations that the ECB will continue its tightening cycle at its upcoming monetary policy meeting in September limit the Euro’s downside potential against the British Pound. The prospect of higher European interest rates could continue to support the shared currency if inflationary pressures persist.

The British Pound, however, retains its own sources of support. In the UK, the Consumer Price Index (CPI) rose 2.9% YoY in July, up from 2.6% in June and in line with expectations. Core inflation, which excludes the most volatile components, remains unchanged at 2.6%.

Investors are balancing these figures against recent signs of a cooling UK labor market. The absence of a major surprise in the inflation data, combined with slightly softer employment conditions, limits the need for particularly aggressive monetary tightening from the Bank of England (BoE).

Analysts at Danske Bank note that UK inflation data for July were broadly in line with expectations, adding that, "together with yesterday's weak labour market data, the release has taken the top off BoE pricing for the remainder of the year."

Money markets nevertheless continue to price in the prospect of a BoE rate hike by the end of the year, which would lift the Bank Rate from 3.75% to 4%. These expectations provide support to the British Pound and help offset the positive impact of ECB tightening prospects on EUR/GBP.

The pair therefore remains caught between two central banks facing persistent inflation risks. Energy price pressures and stronger producer prices bolster the case for the ECB, while elevated UK inflation keeps the possibility of another BoE rate hike alive, leaving EUR/GBP without a sufficiently strong catalyst to move away from the 0.8580 area.

Analysts at Danske Bank highlight that attention in the Euro area will centre on the ECB’s publication of the minutes from its July meeting due next week, “at which policy rates were left unchanged.” The bank expects the account to “show a bias towards a rate hike in September, which is also fully priced in by markets,” and, consistent with this view, they “continue to expect only one further 25bp rate hike from the ECB.”