EUR/GBP has been one of the most consistent downward trends since the start of the year. Although EUR/$ has fallen further over the last 12 months, GBP has strengthened more vs EUR than the USD since January. Moreover, the pullback seen in EUR/GBP in March-May 2015 was less severe than in EUR/$. In 2015, only CHF has outperformed Sterling vs EUR among G10 currencies following its January de-pegging. We believe EUR/GBP’s relatively steady decline reflects the ongoing outperformance of UK activity, firming price pressures in the form of wage growth which is trumping low inflation prints, and incremental hawkishness in central bank communication.
The momentum towards rate hikes from the Bank of England points to the key difference to other European currencies, in particular SEK. Despite similar strength in activity numbers between UK and Sweden, very weak inflation dynamics have led to the Riksbank easing at every opportunity this year. As we have argued, against the backdrop of ECB QE, Sterling should continue to benefit as the Bank of England moves towards exit from its post-crisis policy accommodation on the back of a strong economy and tightening labour market.
We think the current account deficit overstates the risk to GBP, and the impact from renewed fiscal tightening included in the July government budget will only have modest impacts on the BoE’s growth projections. Although the precise timing of the first rate hike remains the subject of much speculation, and the general policy mix of tight fiscal and loose monetary policy may limit Sterling outperformance on a broad basis, we continue to expect upward pressure on front-end rates further out the forward curve, leading to further currency appreciation vs EUR. We see EUR/GBP at 0.65 in 12 months.