Pound Sterling Surges to 17-Month High Against Euro Amid Diverging Monetary Policy Expectations
The British pound has ascended to its highest level against the euro since April 2022, fueled by market expectations of a less aggressive interest rate reduction strategy by the Bank of England (BOE) compared to the European Central Bank (ECB). This surge comes as investors anticipate the BOE to hold steady on interest rates in its upcoming policy meeting, contrasting sharply with the ECB’s anticipated rate cut. This divergence in monetary policy, coupled with lingering economic and political uncertainties within the eurozone, is bolstering the pound while exerting downward pressure on the euro.
Sterling’s recent rally saw it appreciate by 0.3% to 82.50 pence per euro on Tuesday, marking a significant milestone in its performance against the common currency. Concurrently, UK government bonds, known as gilts, experienced a dip, with yields on 10-year notes reaching 4.33%, a level unseen since late November. This inverse relationship between sterling’s strength and gilt yields suggests that market confidence in the UK economy is rising, even as borrowing costs increase. Investors appear to be pricing in the BOE’s commitment to tackling inflation, even at the potential cost of slightly slower economic growth.
The market’s anticipation of the BOE’s steadfast approach stems from the UK’s relatively robust economic performance and persistent inflationary pressures in certain sectors. While growth has moderated, it remains resilient, supporting the case for maintaining current interest rates. Furthermore, although headline inflation has eased, core inflation, which excludes volatile food and energy prices, remains stubbornly high. This suggests that underlying inflationary pressures persist, requiring a more cautious approach to monetary easing. The BOE is likely to prioritize controlling inflation, even if it means slightly slower economic growth in the short term.
In contrast, the ECB is widely expected to implement a 0.25 percentage point interest rate cut on Thursday, aiming to stimulate the eurozone’s flagging economy. The euro area has been grappling with weaker economic data, raising concerns about a potential recession. The ECB is therefore under pressure to implement measures to bolster economic activity and prevent a prolonged downturn. This divergence in monetary policy trajectories is at the heart of the pound’s recent strength against the euro. As the BOE maintains its current stance while the ECB eases, the relative attractiveness of sterling-denominated assets increases.
Looking further ahead to 2025, market forecasts suggest a widening gap in interest rate differentials between the UK and the euro area. Current swap rates indicate an anticipated easing of 80 basis points by the BOE and approximately 125 basis points by the ECB over this period. This projected divergence further reinforces the expectation of continued sterling strength against the euro. The greater easing anticipated from the ECB suggests a more pessimistic outlook for the eurozone economy, further diminishing the appeal of euro-denominated assets.
Beyond the diverging monetary policy paths, the euro’s weakness is also attributed to several other factors, including the potential impact of US trade tariffs on the region’s exports. The threat of trade disputes and protectionist measures creates uncertainty for European businesses and could negatively impact economic growth. Furthermore, political instability in key eurozone economies like France and Germany adds to the downward pressure on the euro. Political uncertainty can erode investor confidence and lead to capital flight, weakening the currency. The combination of these economic and political headwinds creates a challenging environment for the euro, further contributing to the pound’s recent ascent.
