The euro has risen in eight of the past nine sessions against sterling even though Bank Rate remains 150 basis points above the European Central Bank deposit rate, unchanged since mid-June. The move has instead tracked the forward curve: since mid-July, markets have steadily priced a narrower rate gap six months out, driven mainly by UK repricing after the cross bottomed just over 0.8450. The ECB held rates at 2.25% on 23 July but signalled a September increase, with around 70% odds now priced for a quarter-point move, while warning that elevated energy costs could feed through via second-round effects.
The Bank of England decision on Thursday is framed by softer UK data, with June CPI at 2.6%, services inflation at 3.6% and pay growth slowing; forecasters see inflation peaking near 3% later this year, versus a previously watched 4% threshold for second-round risks. Ahead of the 11:00 GMT meeting, markets expect a 3.75% hold on a 7-2 vote, while euro-area releases start 09:00 GMT with Q2 growth seen at 0.2% QoQ after a 0.2% contraction and 0.5% YoY versus 0.3%, unemployment at 6.2% and sentiment at 96 from 95; Friday’s flash inflation is seen at 2.9% YoY from 2.8% with core at 2.4%. Technical markers include resistance near the 50-day EMA just under 0.8600 and the 200-day EMA just under 0.8650, with support at 0.8550, 0.8500 and the mid-July base just over 0.8450; the stated invalidation is a daily close below 0.8500.
Market Dynamics and Interest Rate Expectations
We see the Euro strengthening against the Pound, marking its eighth gain in nine sessions despite the official interest rate gap remaining unchanged at 150 basis points. While the Bank of England’s rate sits at 3.75% and the European Central Bank’s deposit rate is at 2.25%, derivative traders must look past the current spread to what the forward curve is predicting. Recent market data shows the expected rate differential for the next six months has been steadily shrinking, driven primarily by shifting expectations for British monetary policy.
This shift is backed by hard economic data, as UK headline inflation cooled to 2.6% in June with services inflation dropping to 3.6%. Historically, when the gap between expected central bank rates narrows, the EUR/GBP cross tends to rebound sharply from its multi-month lows. With the British front-end rate pricing in fewer hikes, the premium that supported the Pound’s July rally is quickly evaporating.
Outlook and Trading Strategies
We expect the upcoming central bank meetings to act as a major catalyst for derivative positioning. While the ECB has signaled a potential rate hike in September with a 70% probability priced in by the markets, the Bank of England is widely anticipated to hold its rate steady at 3.75% this Thursday. If the Bank of England delivers a softer tone or a heavily lopsided vote split to hold, it will confirm that British rates have peaked, further weakening the Pound.
We advise derivative traders to adopt a bullish bias on the EUR/GBP cross as long as it holds above the 0.8550 support shelf. Utilizing short-term call options or bull call spreads can capture the upside toward the 50-day exponential moving average near 0.8600, and potentially the 200-day average near 0.8650. However, traders should place tight invalidation triggers on a daily close below 0.8500 to protect against any unexpected hawkish surprises from the Bank of England.
