For most of July sterling seemed pretty unstoppable vs. the single currency, but after EUR/GBP hit a near 4yr low early last week, the strains have been starting to show. The main catalyst was the surprise fall in GDP data seen in Q2 (down 0.7%), but it’s not all bad news for the pound. Since then, EUR/GBP has been pushing tentatively lower and continues to do so this morning, getting that much closer to the 0.78 level. Even though there is some talk of the euro turning more into a funding currency in the wake of the ECB’s cut in rates earlier in the month, there is little evidence of this at least on this cross. The correlation between EUR/GBP and the spread between 2yr interest rates in the UK and eurozone (using swap rates) has been declining, with the move seen this month happening at a time when interest rates spreads were pretty steady.
That said, the shifting expectations of the direction of both central banks could well play a role on the cross this week. Expectations ahead of Thursday’s ECB meeting are building, not of rates, but of the possibility that it is set to sanction a more aggressive approach with regards to buying the bonds of peripheral eurozone nations. Meanwhile, having only just sanctioned further bond purchases, there are few expectations that the Bank of England is going to follow through this early on with a cut in the official bank rate from the current 0.50%. How any potential ECB action will impact on sterling is a harder call. For most of the past two years, the single currency has displayed a negative correlation with peripheral yields, weakening as yields in the like of Italy and Spain move higher. So, if the ECB does follow through with actions after last week’s words, EUR/GBP could well struggle to push new lows for the year.
