EUR/GBP remains under pressure on Wednesday, with the Euro (EUR) extending its decline against the British Pound (GBP) for a fifth consecutive day as traders reassess the monetary policy outlook for the European Central Bank (ECB) and the Bank of England (BoE) amid rising concerns about an Oil-driven inflation shock linked to the ongoing US-Iran conflict.
At the time of writing, the cross is trading around 0.8628, hovering near its lowest level since February 4.
Before the US-Iran war erupted, markets were increasingly confident that the BoE would lower interest rates at next week’s monetary policy decision, with traders pricing in roughly an 80% probability of a rate cut.
However, the prospect of renewed inflationary pressures from elevated Oil prices has clouded the policy outlook, prompting policymakers to proceed cautiously and potentially delay rate cuts.
David Miles, a senior figure at the Office for Budget Responsibility (OBR), warned that energy shocks could push consumer prices higher. “If there is no change in the picture on prices from now on, we estimate something like 1% higher consumer prices by the end of the year,” Miles said.
In the meantime, the International Energy Agency (IEA) has agreed to release around 400 million barrels of Oil from its members’ strategic reserves to counter soaring global energy prices.
Meanwhile, the Euro remains on the back foot even as investors price in the possibility of a European Central Bank (ECB) rate hike, with market pricing indicating a roughly 60%-70% probability of a rate increase by June.
The divergence in policy expectations is weighing on EUR/GBP, with fading BoE rate-cut bets providing stronger support to the Pound than ECB tightening expectations are providing to the Euro.
Traders remain wary that persistently elevated Oil prices could weigh more heavily on Europe, a significant net energy importer, raising stagflation concerns amid the fragile growth outlook across the Eurozone economy.
ECB policymaker Joachim Nagel said on Wednesday that the central bank would “act decisively” if an energy price spike feeds into durably higher inflation, warning that the risk of higher inflation has increased while the economic outlook has deteriorated.
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it.
Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.
Source: https://www.fxstreet.com/news/eur-gbp-weakens-as-fading-boe-rate-cut-bets-support-the-pound-202603111502
