EUR/GBP edges higher on Thursday, though it lacks strong follow-through buying, as choppy price action persists amid heightened volatility across the FX space. Ongoing geopolitical tensions in the Middle East keep markets on edge, with the Euro (EUR) relatively outperforming the British Pound (GBP). At the time of writing, the cross trades around 0.8726, hovering near one-month highs.
US President Donald Trump, in his address to the nation, signaled that military operations against Iran will continue and offered no clear timeline for ending the conflict. This points to prolonged supply disruptions through the Strait of Hormuz, keeping Oil prices elevated.
Rising Oil prices are adding to inflation pressures while also raising risks to economic growth, a combination that could force central banks to maintain a tighter monetary policy stance. Traders are already pricing in 2-3 rate hikes from both the European Central Bank (ECB) and the Bank of England (BoE).
However, both economies remain vulnerable to an energy shock due to their reliance on imported energy. The Eurozone appears relatively better positioned, with inflation moving closer to the ECB’s 2% target. In contrast, the UK faces a more challenging backdrop, with a weakening labor market, slowing economic growth, and inflation still running well above the BoE’s 2% target.
ECB policymakers also struck a cautious tone on Thursday. Governing Council member Gediminas Šimkus said, “It is too early to say what we’ll need to do in April,” adding that “caution is needed on rates as the situation is changing.” Fabio Panetta, Member of the Executive Board of the ECB, said that “tensions in energy markets are a cause for concern not only for the immediate impact on inflation and growth, but also for financial stability.”
BoE Governor Andrew Bailey said on Wednesday that “markets may be getting ahead of themselves in pricing in interest rate hikes,” adding that “we look at inflation expectations very carefully, but short-run often follows headline inflation.”
ING’s Francesco Pesole notes that EUR/GBP volatility has largely reflected shifting rate differentials, with Bank of England (BoE) pricing likely to fall faster than that of the European Central Bank (ECB). With the BoE already seen as closer to rate cuts before the war and the United Kingdom (UK) expected to face the largest growth hit among OECD economies from the energy shock, ING maintains an upside bias in EUR/GBP, targeting the 0.8800 level.
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it.
Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.
Source: https://www.fxstreet.com/news/eur-gbp-edges-higher-in-choppy-trade-as-middle-east-tensions-buoy-euro-over-pound-202604021436
