GBP/EUR exchange rate rallies as markets reprice ECB rate hike expectations

The Pound Euro exchange rate rallied this week in response to investors moderating their bets for the next European Central Bank (ECB) interest rate hike. 

Euro dented by more cautious messaging from the ECB 

The Euro got off to a poor start this week, with the single currency being forced to relinquish some of the gains made following the previous week’s ECB driven gains. 

This came as ECB policymakers sought to temper rate hike expectations, with President Christine Lagarde warning of risks to the outlook, while governing council member, Francois Villeroy de Galhau suggested the market reaction to the ECB’s most recent policy meeting may have been too strong. 

The EUR selling bias was reinforced in the latter half of the week after the European Commission slashed its EU growth forecast for 2022, in addition to being pressured by its negative correlation with the US Dollar, which surged following the release of a hotter-than-expected inflation print. 

Meanwhile the Pound faced some resistance at the start of the week amidst concerns the UK’s impending cost-of-living crisis could undermine economic growth in 2022. 

Sterling was then able to largely rally through the middle of the week on the back of the Euro’s weakness, with the GBP/EUR exchange rate rising in spite of comments from Bank of England (BoE) Chief Economist Huw Pill in which he warned the bank’s interest rate outlook was uncertain beyond the next few months. 

The Pound then closed the week on a positive note after the UK’s latest GDP figures reported a larger-than-expected expansion of growth in 2021. 

Will rising inflation bolster the Pound? 

Turning to next week’s session, a key focus for markets will be the publication of the UK’s consumer price index. 

Economists forecast January’s CPI release will report another acceleration of domestic inflation, which could bolster the Pound on the expectation it will place more pressure on the BoE to continue hiking interest rates. 

However, GBP investors will also be paying close attention to the UK’s latest jobs report, particularly in regards to average earnings. If wage growth continued to slow at the end of 2021, then Sterling could face some headwinds due to renewed cost-of-living concerns. 

Meanwhile the publication of Germany’s ZEW economic sentiment index will be in the spotlight for EUR investors next week, with an improvement in morale potentially bolstering the Euro. 

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