The EUR/GBP exchange rate started 2022 by falling to a record low since February 2020. This is due to the more hawkish projections of the UK central bank (BoE) interest rates.
The EUR/GBP exchange rate started 2022 by plunging to a record low since February 2020, due to the decision of the British central bank (BoE) to raise interest rates to 0.25 percent in mid-December 2021. At the time of writing (12/January), the neighboring currency pair it is still slumped in the range of 0.8330s. A number of analysts even indicated that the pound sterling will be more resilient in the short term.
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EUR/GBP Daily Chart via TradingView |
The results of the latest Barclays research reveal the fact that the pound sterling was the best performing G10 currency during the first week of 2022. Sterling's appreciation was mainly due to the release of accumulated short positions, as well as market expectations for a further rate hike in February. If these two topics continue to develop in the weeks to come, the GBP will be even more resilient.
CFTC data at the end of last year showed that the majority of trading positions on GBP were still short. Consequently, sterling has the potential to continue to strengthen as more traders close their short positions. The urgency of closing short positions is getting higher due to strong speculation surrounding the BoE's second interest rate hike.
Money markets are currently pricing in a 75 percent chance of a rate hike at the Bank of England's MPC meeting on February 3, 2022. That opportunity was boosted by the BoE's rate hike last December, as well as the Federal Reserve's more hawkish policy direction in the latest FOMC minutes. The faster the "Fed rate hike" projection, the faster the "BoE rate hike" projection.
Barclays assesses that the pound sterling will continue to be boosted by closing short traders' positions in the short term. Sterling will likely stagnate again if the market has accumulated long positions in the future.
Martinez said, "We continue to expect GBP to perform well in the weeks ahead as these drivers gain further momentum."
Contrary to the BoE, the European Central Bank (ECB) has the potential to keep interest rates near zero for a longer period of time. ECB Executive Board member Isabel Schnabel said at the end of last week that rising energy prices might force the central bank to start highlighting inflation. However, market participants ignored the comments because the consensus thought it was still too early for the ECB to talk about tightening monetary policy.
The gap in the direction of the BoE-ECB policy is behind the current slump in the EUR/GBP rate. However, the GBP/USD struggle and the pound's long-term projections are more complicated. The reason is, the BoE is not necessarily raising interest rates faster and more than the US Federal Reserve. There is a big question mark regarding how big the realization of the upcoming "BoE rate hike" will be, along with analysts' concerns that market players have too much expectation on the central bank, known as the "unreliable boyfriend".
"The surprise BoE rate hike in December immediately triggered a recalculation of (projected) short-term rate hikes. However, the market has historically struggled to price in the BoE's terminal interest rate well above 1 percent," said Erick Martinez, an FX strategist at Barclays.
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