Euro rebounds against British Pound on diverging ECB-BoE interest rate paths

• EUR/GBP recovers as cautious BoE signals weigh on the British Pound.
• BoE Governor Andrew Bailey acknowledges upside inflation risks but stops short of signalling an imminent rate hike.
• The ECB is widely expected to deliver its second rate hike of the year on Thursday.

EUR/GBP rebounds on Tuesday after slipping to a six-day low earlier in the day. The recovery comes as the British Pound (GBP) weakens against most of its major peers following cautious remarks from Bank of England (BoE) Governor Andrew Bailey. At the time of writing, the cross trades around 0.8587 after touching an intraday low near 0.8570.

Testifying before the UK Treasury Select Committee during the Monetary Policy Report hearing, Bailey said, “Risks to inflation are to the upside,” while adding, “I do not think we are on the verge of a recession.” He noted that “the market’s BoE rate curve reflects investors’ concern about further energy price rises” and said, “I want to dispel the idea that we have a secret plan to raise rates unconditionally.”

The comments reinforce expectations that the BoE will leave the Bank Rate unchanged at 3.75% on September 17. All 65 economists surveyed by Reuters between September 4 and 8 expect the Monetary Policy Committee to keep rates on hold next week, while 57 expect no change for the rest of the year.

In contrast, the European Central Bank (ECB) is widely expected to raise its deposit rate by 25 basis points to 2.50% on Thursday, marking its second increase this year. This policy divergence should keep the Euro (EUR) favoured against the Pound.

UK fiscal concerns also weigh on the Pound. UK Chancellor John Healey delivered his first major speech since taking charge of the Treasury on Monday, insisting the UK economy was “turning a corner” even as he acknowledged the growing burden of high government borrowing costs on businesses and the public finances.

Analysts at Rabobank caution that the underlying backdrop for the Pound remains fragile, highlighting that “the gilts market has the potential to be particularly sensitive to negative budget-related news because of the relatively high amount of foreign ownership.” In their view, “overseas buyers can be more reactionary to a souring of the news flow, and in the case of the gilts market this can have a detrimental impact on the pound.”

Rabobank also flags that current market positioning “may leave the pound vulnerable,” with “a hawkish takeaway from the BoE meeting next week” seen as already priced in. As a result, they warn that “the pound could slip on anything that can be construed as dovish.” “On the back of this factor, coupled with the pound’s potential sensitivity to fiscal matters,” the bank concludes that “we expect EUR/GBP to be biased higher, towards 0.87 on a 3-month view.”