Sterling climbs to 21-month high against euro as rate cut bets fade

Sterling has risen to a 21-month high against the euro, as more persistent price pressures in the UK have prompted investors to bet that the Bank of England will start lowering interest rates much later than its Eurozone counterpart. 

The pound climbed 0.03 per cent on Wednesday to trade at a high of £0.8482 per euro, a level last seen in August 2022. Sterling has now gained 2 per cent against the common currency since the start of the year as investors push back expectations for BoE rate cuts at a time when the European Central Bank remains on track to reduce borrowing costs next month. 

“We’re at a period in time when short-term interest rates dictate everything in foreign exchange,” said Kit Juckes, a currency strategist at Société Générale. Juckes added that the pound has been “really cheap” since 2016’s vote to leave the EU, meaning even relatively minor shifts in expectations for monetary policy can spark significant gains. 

The pound has been boosted this year as the UK economy has performed better than many had expected, while lingering inflation concerns have increased the prospect of UK interest rates staying higher for longer. Investors say sterling has also been supported by the prospect of an imminent election, with optimism that a change in government could help to alleviate the political uncertainty that has weighed the currency down in recent years.

UK inflation fell to a three-year low of 2.3 per cent last week but the services component, seen as an indicator of underlying price pressures in the economy and closely followed by the BoE, was 5.9 per cent, significantly higher than economists had forecast.

Markets have all but ruled out a rate cut next month, having been evenly split on the prospect at the beginning of last week.

Meanwhile, the ECB remains on track to start cutting rates on June 6, and is expected to deliver at least two quarter-point reductions by the end of the year. 

The ECB’s chief economist Philip Lane told the Financial Times in an interview this week that the central bank was ready to start lowering rates at its next meeting “barring no major surprises”, with EU inflation figures due on Friday. 

The shift in rate expectations in the UK has pulled pricing more in line with the Federal Reserve, and has also prompted traders to rip up bearish sterling bets, according to data from the US Commodity Futures Trading Commission, which showed positioning returning to the “net long” range last week.

“We have been running a long euro-sterling trade view and we scrapped it a week ago on the back of the CPI print,” said Derek Halpenny, head of research at MUFG. “The BoE won’t be cutting rates in June like we expected.”

Sterling’s resilience comes after the UK’s surprise decision to call an election on July 4, which investors say could support the currency if it ushers a period of political stability and an improvement in trading relations with the EU under a potential Labour government. 

“Speaking to international investors over a number of years its been about the UK’s political turmoil and uncertainty. Perhaps there’s an element of things could get better,” said Halpenny. 

The pound is also the only of the group of 10 developed world major currencies that has risen against the dollar this year, rising 0.1 per cent.