EUR/GBP Rises as Bank of England Expected to Cut Rates

The EUR/GBP exchange rate experienced upward movement during the early European session on December 7, 2023, driven by expectations surrounding monetary policy decisions from both the Bank of England (BoE) and the European Central Bank (ECB). The British Pound (GBP) weakened significantly following the release of softer-than-expected inflation data, which further cemented predictions of a rate cut by the BoE.

Current forecasts indicate that the BoE will reduce its key interest rate to 3.75% later today, while the ECB is expected to maintain its current policy rates, which have remained stable since July. As a result of these developments, the EUR/GBP cross strengthened to approximately 0.8785 during Thursday’s trading session.

The UK’s headline Consumer Price Index (CPI) showed an annual increase of 3.2% in November, down from 3.6% in October, according to the Office for National Statistics. This figure fell short of the anticipated 3.5%, contributing to the GBP’s decline against the Euro. Additionally, core CPI, which excludes volatile food and energy prices, rose 3.2% year-on-year, aligning with the previous month’s figure but below market expectations of 3.4%.

As interest rate futures suggest a near certainty of a quarter-point rate cut at today’s BoE meeting, the GBP remains under pressure. There is also speculation regarding potential further cuts in 2026. In contrast, the ECB is widely expected to keep its policy rates steady, reinforcing the Euro’s position against the Pound.

Market Reactions and Future Expectations

The anticipated decision from the BoE has attracted considerable attention from investors, particularly in light of the prevailing economic conditions in the UK. With inflation falling below the BoE’s target of 2%, the central bank is likely to consider reducing rates to stimulate growth. A reduction in interest rates generally makes borrowing cheaper, but it can also weaken the currency’s value as it becomes less attractive to investors seeking higher yields.

On the other hand, the ECB has indicated a cautious approach to adjusting its policy rates. The key deposit rate has been held at 2% since July, and comments from ECB officials, including Isabel Schnabel and Philip Lane, have suggested that the central bank may be done with rate cuts for now. Most economists polled by Reuters predict the ECB will maintain current rates through 2026 and 2027, with wide-ranging expectations for future adjustments.

Understanding the Role of Central Banks

The role of the Bank of England extends beyond simply adjusting interest rates; it aims to ensure price stability within the UK economy. When inflation exceeds its target, the BoE typically responds by raising rates, making borrowing more costly. This policy can bolster the value of the GBP as it attracts international investment. Conversely, if inflation falls below target, it may lead to rate cuts, which can weigh on the currency’s strength.

Quantitative Easing (QE) is another tool employed by the BoE in times of economic distress. This process involves the central bank increasing the money supply by purchasing assets, usually government bonds, to stimulate lending and spending. While effective in some scenarios, QE can lead to a depreciation of the Pound.

On the flip side, Quantitative Tightening (QT) occurs when the economy strengthens and inflation rises. During QT, the BoE reduces its bond holdings, which can positively influence the GBP’s value.

The decisions made by the BoE and ECB will be closely monitored, as they have significant implications for the financial markets and the broader economy. As the day unfolds, all eyes will be on the announcements from both central banks, which are likely to shape currency movements and investor sentiment in the near future.