Euro Holds Tight Range vs Pound Prior to Fresh Catalysts

Key Moments

Euro Trades Steady in Quiet Market Conditions

The Euro (EUR) advanced for a second straight session against the British Pound (GBP) on Wednesday, with EUR/GBP hovering in the middle of its monthly range. The cross extended its rebound to 0.8560 after touching 0.8546 on Tuesday, as market participants awaited US PCE inflation figures in the absence of significant scheduled releases in both the Eurozone and the United Kingdom.

Trading conditions remained subdued, with the lack of major data from Europe and the UK limiting directional drivers for the currency pair.

German Data Lends Support to the Single Currency

The Euro found some support from German macroeconomic releases published on Tuesday. Second-quarter German Gross Domestic Product figures were revised higher, while the IFO Business Climate Index for August rose to its strongest level in one year.

The IFO report indicated that both assessments of the current business situation and expectations for the economic outlook improved more than markets had anticipated.

ING: Carry Appeal Continues to Back Sterling

With the UK data calendar largely empty this week, ING foreign exchange strategists highlighted the ongoing influence of yield-related factors on the Pound. They noted that in the existing “low volatility environment, sterling is probably still enjoying some carry demand given it is one of the highest, volatility-adjusted currencies in G10.” Reflecting this backdrop, the bank observed that “EUR/GBP can probably hang around these 0.8550 levels for the time being.”

ING further commented that “our call is that the BoE does not need to hike again, but that the realisation of that may not weigh on sterling until later in the year,” implying any negative impact on the Pound from Bank of England policy expectations may emerge only gradually.

Rate Differentials and Outlook for EUR/GBP

Looking ahead, ING analysts pointed out that, “if calm is indeed restored in the bond market, expect the pair to return to tracking short-term rate differentials closely.” In line with this view, they reiterated a positive stance on EUR/GBP, stating that “we still expect no hikes and a move to 0.870 in the coming months on the back of dovish repricing in the GBP front end.”

Background: Euro and Key Drivers

The Euro is the currency used by 20 European Union member states in the Eurozone. It is described in the article as the second most heavily traded currency globally after the US Dollar, accounting in 2022 for 31% of all foreign exchange transactions and generating an average daily turnover of over $2.2 trillion.

According to the article, EUR/USD is the most traded currency pair worldwide, representing an estimated 30% of all transactions. It is followed by EUR/JPY at 4%, EUR/GBP at 3%, and EUR/AUD at 2%.

Role of the ECB in Euro Dynamics

The European Central Bank (ECB), headquartered in Frankfurt, Germany, serves as the central bank for the Eurozone. It sets interest rates and directs monetary policy with the primary objective of maintaining price stability, either by controlling inflation or supporting growth.

The ECB’s main policy tool is adjusting interest rates. Relatively higher interest rates, or expectations of such moves, generally benefit the Euro, while lower rates tend to have the opposite effect. Monetary policy decisions are made by the ECB Governing Council at eight scheduled meetings each year, involving the heads of Eurozone national central banks and six permanent members, including ECB President Christine Lagarde.

Impact of Inflation Data on the Euro

Eurozone inflation is measured by the Harmonized Index of Consumer Prices (HICP). The article notes that if inflation exceeds expectations, particularly if it rises above the ECB’s 2% target, the central bank is compelled to raise interest rates to bring price growth back under control.

Higher interest rates relative to other economies typically support the Euro, as they make Eurozone assets more attractive to global investors.

Economic Indicators and Their Influence

Data releases that reflect the health of the Eurozone economy can significantly influence the Euro. The article highlights indicators such as Gross Domestic Product, Manufacturing and Services PMIs, employment figures, and consumer sentiment surveys.

Strong economic results tend to be positive for the Euro, as they can attract additional foreign investment and may encourage the ECB to consider higher interest rates. Conversely, weaker data usually weighs on the currency. Economic releases from Germany, France, Italy, and Spain are noted as particularly important, given that these four economies account for 75% of Eurozone output.

Trade Balance as a Currency Driver

The Trade Balance is presented as another key metric for the Euro. It measures the gap between export earnings and import expenditures over a given period. A positive balance, where exports exceed imports, can strengthen a currency due to foreign buyers needing to purchase the local currency to pay for goods. A negative balance tends to have the opposite effect.