Currency markets turned again this week as traders re-evaluated the outlook for UK interest rates relative to the eurozone. EUR/GBP experienced upward volatility on Tuesday after the gap in expected policy moves narrowed, but eased back on Wednesday morning when European Central Bank rate expectations softened.
ING highlighted two principal reasons the pound could face a deeper dovish repricing than the euro. First, the bank notes that the Bank of England was in a position to cut rates even before the recent conflict began. Second, ING argues the United Kingdom is likely to suffer the largest growth hit from the current energy shock among OECD economies, which supports a dovish case for the BoE.
Bank of England officials have also sounded less hawkish in recent off-meeting comments, according to ING. The combination of weaker rhetoric and heightened energy-related growth risks underpins ING's bias toward further upside for EUR/GBP. The bank expects the market to price out the entirety of the BoE tightening and regards a move to 0.880 for EUR/GBP as a realistic target.
Market snapshots showed the pound firming against the U.S. dollar and the euro losing ground to sterling mid-morning. At 10:55 AM GMT, GBP/USD was quoted at 1.3310, up 0.6%, while EUR/GBP was 0.8717, down 0.2%.
Volatility in the pound has picked up since the conflict in the Middle East began on February 28. Recent comments cited by market reports included U.S. President Donald Trump saying U.S. military forces will leave Iran in two to three weeks and asserting his objective of eliminating the country's nuclear threat has been achieved. Those developments sit alongside central bank signals as key drivers of recent moves.
The Bank of England's Financial Policy Committee warned on Wednesday that the Middle East conflict has produced a substantial shock to the global economy. The committee said this shock increases risks to financial stability through higher energy prices and greater market volatility.
The conflict between Israel and the United States, and Iran has effectively halted shipping through the Strait of Hormuz and reduced energy production in the Gulf region, according to market accounts. Oil prices have surged above $100 per barrel, with Brent crude trading more than 60% above pre-conflict levels. European and UK natural gas prices have risen by more than 70% relative to their pre-conflict levels.
ING's view of a dovish repricing in UK rates is informed by central bank communication and the outsized economic exposure of the UK to the energy shock, the bank says. Traders will be watching further central bank signals and energy price moves for guidance on the next leg for EUR/GBP and other cross rates.