British Pound outperforms Euro as traders reassess ECB and BoE outlook after inflation data

• EUR/GBP falls for a third consecutive day as traders reassess the interest rate outlook following the latest inflation data from the Eurozone and the United Kingdom.
• Eurozone inflation accelerated to 3.0% in April, while ECB’s Wunsch signaled that further policy tightening is likely.
• UK inflation and employment data cooled more than expected, prompting traders to trim Bank of England rate hike bets.

The Euro (EUR) weakens against the British Pound (GBP) on Wednesday, with EUR/GBP extending losses for a third consecutive day as traders digest the latest inflation data from both the United Kingdom and the Eurozone. At the time of writing, the cross is trading around 0.8654, hovering near one-week lows.

Data released by Eurostat showed that the Eurozone Harmonized Index of Consumer Prices (HICP) rose to 3.0% YoY in April from 2.6% in March, driven largely by higher energy prices, while Core HICP eased to 2.2% YoY in April from 2.3% in the previous month.

Inflation remaining above the European Central Bank’s (ECB) 2% target for a second consecutive month has reinforced expectations that policymakers could be forced to raise interest rates in the coming months, with markets currently pricing in the possibility of two to three rate hikes by year-end. However, concerns that higher energy costs and the Eurozone’s heavy dependence on imported energy could slow economic growth may limit the ECB’s ability to tighten monetary policy too aggressively.

ECB policymaker Pierre Wunsch said on Wednesday that the Eurozone is “at the beginning of an inflation problem” and that the ECB “will have to react at some point.” Wunsch added that the likelihood of a June rate hike is “quite high” and said market expectations for around 75 basis points of additional tightening this year are “reasonable.”

In the United Kingdom, the Consumer Price Index (CPI) slowed to 2.8% YoY in April from 3.3% in March, missing market expectations of 3.0%, while Core CPI eased to 2.5% YoY from 3.1% previously, coming in below forecasts of 2.6%.

Following the release, and combined with softer employment data released on Tuesday, traders trimmed some Bank of England (BoE) rate hike expectations, with BHH reporting that the swaps curve is now pricing around 66 basis points of tightening over the next 12 months, down from 75 basis points previously.

The softer UK inflation figures give the BoE more room to assess the impact of rising Oil prices on the economy while still keeping future rate hikes on the table. Meanwhile, expectations that UK interest rates could remain relatively higher than those in the Eurozone continue to support the Pound against the Euro in the near term.

Traders are also monitoring political developments in the United Kingdom amid speculation surrounding a potential leadership change, which could weigh on Sterling sentiment if uncertainty intensifies.