The European Central Bank (ECB) has kept its policy rates unchanged, maintaining a slightly hawkish stance due to resilient economic growth. ECB President Christine Lagarde downplayed recent softness in inflation and concerns over the Euro’s strength, emphasising that the currency remains within its average range.
The stance of the ECB, in contrast to the Bank of England’s more dovish approach, suggests potential upward movement for the EUR/GBP. Meanwhile, the EUR/USD exchange rate is expected to be influenced mainly by factors pertaining to the United States in the near term.
Policy Divergence in 2025
The policy divergence we first identified in early 2025 between a slightly hawkish European Central Bank and a dovish Bank of England remains the dominant theme. This fundamental difference in tone is creating sustained opportunities in the currency markets. The ECB continues to signal that interest rates will be held for some time.
This ECB stance is being reinforced by current data, with Eurozone core inflation for January 2026 coming in at 2.5%, slightly ahead of the 2.3% forecast. President Lagarde has also successfully downplayed the strength of the Euro, which, looking back, has remained within its historical range throughout 2025. This gives the central bank room to maintain its steady policy without worrying about the exchange rate.
In contrast, the UK’s economic outlook has weakened, confirming the cautious approach from the Bank of England. The final reading for Q4 2025 GDP showed a 0.2% contraction, fueling speculation that rate cuts may be necessary before the summer. The market is now pricing in a greater than 60% chance of a BoE rate cut by June 2026.
Upside Risk for EUR/GBP
Given this widening policy gap, we continue to see upside risk for the EUR/GBP cross. Derivative traders should consider buying EUR/GBP call options with April or May 2026 expiry dates. This strategy allows for participation in potential upside while clearly defining the risk involved.
Separately, the broader market narrative is being driven by US factors, specifically the expectation of a weaker dollar. The most recent Non-Farm Payrolls report showed job growth slowing to 155,000, missing expectations and signaling a cooling US economy. This has led markets to anticipate that the Federal Reserve will begin its rate-cutting cycle sooner than the ECB.
This expected dollar weakness should act as a tailwind for EUR/USD. To position for this, traders could look at long positions in EUR/USD futures contracts. Alternatively, buying EUR/USD call spreads offers a risk-defined way to benefit from a gradual move higher in the pair over the coming months.
