Euro steadies vs British Pound as German political uncertainty, PMIs cap direction

EUR/GBP trades around 0.8575 on Monday at the time of writing, virtually unchanged on the day. The Euro (EUR) struggles to regain bullish momentum against the British Pound (GBP), as political concerns in Germany partly offset support from falling Oil prices.

German political uncertainty returns to the spotlight after Chancellor Friedrich Merz’s party suffered a setback in regional elections over the weekend. Merz described the result as a “disaster” while reiterating his intention to remain in office and pursue the economic reforms already underway. The political backdrop keeps investors cautious toward the Euro at the start of the week.

Lower Oil prices, however, provide a positive counterweight for the common currency. Brent crude falls below the $100 level and trades more than 8% below last week’s highs. Lower energy costs are generally supportive for Eurozone economies, which rely heavily on energy imports, as they ease cost pressures on businesses and consumers.

Investors are also assessing the monetary policy outlook for the European Central Bank (ECB) and the Bank of England (BoE), two key drivers of the interest-rate differential between the Euro and the British Pound.

ECB President Christine Lagarde stressed that upcoming interest-rate decisions will depend on economic data and will be taken on a meeting-by-meeting basis. In the United Kingdom (UK), BoE Governor Andrew Bailey suggested that further monetary tightening could still be necessary, helping the British Pound retain some support.

Rabobank sees December ECB hike as likely but largely temporary

Strategists at Rabobank say their “new energy price forecasts make another rate hike more likely than not,” and now expect the ECB “to raise the deposit facility rate by 25bp in December, to 2.75%.” They stress that “this is not a shift to a stronger policy response,” but rather a calibrated reaction to an “additional energy shock” that, in their view, “hits inflation harder and earlier than economic activity.” Against that backdrop, they argue that “some further tightening may be required to keep expectations anchored, and to prevent second round effects,” leading them to “pencil in an additional rate hike in December.”

However, Rabobank emphasises that this is not the start of a sustained tightening cycle. “Considering that energy prices should start to abate in March, we believe policymakers won’t need to keep up that appearance for much longer. Thus, we forecast just one additional hike,” they write. While they acknowledge that “the longer high energy prices persist, the greater the risks that such second-round effects could take hold,” they note that “that’s precisely what the previous two hikes and a December follow-up seek to mitigate.” As long as “data and surveys do not indicate that second-round effects may materialise, the ECB need not respond more forcefully,” they add.

In terms of the medium-term policy path, Rabobank argues that “any deposit facility rate increases above the current 2.50%” should be seen as “temporary,” and that “the ECB will probably revert these in the second half of 2027.” They also highlight that this is “another reason why we haven’t factored in a March hike yet: monetary policy famously works with long and variable lags, so the ECB will probably be looking beyond the tail-end of the energy-driven inflation spike by then.”

Market attention now turns to this week’s macroeconomic calendar. Christine Lagarde is due to speak in Frankfurt later on Monday, while preliminary September Purchasing Managers Index (PMI) data for the Eurozone and the UK, scheduled for Wednesday, could provide fresh clues about economic momentum in both regions and offer EUR/GBP a clearer directional catalyst.