Q4 Top Trade: Short EUR/GBP
- The Bank of England is turning more hawkish while the European Central Bank remains steadfastly dovish, continuing to insist that a jump in inflation will be transitory and that no action is therefore required to bring it down.
- If the ECB persists with that line, then EUR/GBP could fall below the 2021 low at 0.8450 recorded on August 10.
Short EUR/GBP, Bank of England Turns Hawkish
September’s meeting of the Bank of England’s monetary policy committee was expected to be routine and, in a sense, it was. The UK central bank left both its benchmark interest rate and its purchases of government bonds unchanged. Yet a second member of the MPC, Dave Ramsden, voted to cut its QE program when previously the sole hawk had been Michael Saunders.
This was significant because Ramsden is a BoE staff member, Deputy Governor for Markets and Banking no less, whereas Saunders is an external member of the MPC who joined it from Citigroup in 2016.
Moreover, the BoE said the case for tightening monetary policy had strengthened, which in turn prompted a shift in money market pricing to a near 100% likelihood that the Bank will raise interest rates from 0.10% to 0.25% by February 2022, compared with just over 60% previously.
Such a swift rate rise, introduced to combat above-target inflation, still seems unlikely, yet the Bank’s comment prompted a drop in EUR/GBP that can be seen on the candlestick highlighted on the daily chart below. The implications of the shift at the MPC could last far longer, conceivably weakening the cross to the 2021 low at 0.8450 recorded on August 10.
That’s because while the BoE is turning more hawkish the European Central Bank remains steadfastly dovish, continuing to insist that a jump in inflation will be transitory and that no action is therefore required to bring it down. If the ECB persists with that line, then EUR/GBP could fall even further.
Chart of EUR/GBP (Daily)
Chart prepared by Martin Essex, created with IG Platform
As the weekly chart that follows shows, once levels around 0.8450 have been reached there is little further support before the lows around 0.83 touched in December 2019 and again in February 2020.
Chart of EUR/GBP (Weekly)
Chart prepared by Martin Essex, created with IG Platform
Moreover, if the markets begin to truly believe that the BoE will raise rates early in 2022, the next step will be starting to price in further rate rises later in the year as it perhaps decides that surging energy prices and supply bottlenecks mean that higher UK inflation will no longer be transitory unless it acts swiftly to subdue it.
By contrast, a failure to respond by the ECB could be seen increasingly as a policy mistake, damaging its credibility and weakening the Euro as a result.
--- Written by Martin Essex, Analyst
Feel free to contact me on Twitter @MartinSEssex
