- EUR/GBP edges higher despite dovish bets on the ECB’s policy outlook.
- The ECB is widely anticipated to reduce its Deposit Facility rate by 25 basis points to 2.75% on Thursday.
- The British Pound could struggle as recent soft UK data have increased the dovish tone of a BoE’s policy outlook.
EUR/GBP recovers its daily losses, trading near 0.8410 during early European hours on Monday. However, the EUR/GBP cross depreciated amid persistent dovish sentiment surrounding the European Central Bank (ECB) policy outlook.
The ECB is expected to reduce its Deposit Facility rate by 25 basis points (bps) to 2.75% on Thursday, with further rate cuts anticipated in the next three policy meetings. Officials remain optimistic that inflation will sustainably return to the target level of 2%.
On the economic data front, Friday’s report showed the HCOB Eurozone preliminary Composite Purchasing Managers' Index (PMI) for January growing after contracting in the previous two months. According to the flash report by S&P Global, overall business activity expanded, with the Composite PMI rising to 50.2 from 49.6 in November. Economists had forecast a slower decline to 49.7.
Meanwhile, the Pound Sterling (GBP) has gained support following stronger-than-expected preliminary UK S&P Global/CIPS PMI data for January. The UK Composite PMI grew at a faster pace, increasing to 50.9 from 50.4 in December. Economists had predicted modest growth, with expectations at 50.0. The robust performance was driven by strength in both the services and manufacturing sectors.
However, the downside for the EUR/GBP cross could slow as the British Pound could face headwinds. Recent soft UK data—including weaker inflation, retail sales, labor market figures, and sluggish GDP growth in December—has reinforced expectations of a 25 bps rate cut by the Bank of England (BoE) in February. Markets are now pricing in a near-certain reduction in the BoE’s policy rate to 4.5% at its upcoming meeting. This may cap the upside potential for the British Pound in the short term.
Interest rates FAQs
Interest rates are charged by financial institutions on loans to borrowers and are paid as interest to savers and depositors. They are influenced by base lending rates, which are set by central banks in response to changes in the economy. Central banks normally have a mandate to ensure price stability, which in most cases means targeting a core inflation rate of around 2%. If inflation falls below target the central bank may cut base lending rates, with a view to stimulating lending and boosting the economy. If inflation rises substantially above 2% it normally results in the central bank raising base lending rates in an attempt to lower inflation.
Higher interest rates generally help strengthen a country’s currency as they make it a more attractive place for global investors to park their money.
Higher interest rates overall weigh on the price of Gold because they increase the opportunity cost of holding Gold instead of investing in an interest-bearing asset or placing cash in the bank. If interest rates are high that usually pushes up the price of the US Dollar (USD), and since Gold is priced in Dollars, this has the effect of lowering the price of Gold.
The Fed funds rate is the overnight rate at which US banks lend to each other. It is the oft-quoted headline rate set by the Federal Reserve at its FOMC meetings. It is set as a range, for example 4.75%-5.00%, though the upper limit (in that case 5.00%) is the quoted figure. Market expectations for future Fed funds rate are tracked by the CME FedWatch tool, which shapes how many financial markets behave in anticipation of future Federal Reserve monetary policy decisions.
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