EUR/GBP Helped by UK GDP Contraction, but the ECB Looms

EUR/GBP Analysis

The Bank of England has been raising rates non-stop since December 2021, having delivered 515 basis points of hikes since. It is now in a bit of a bind, since it has already delivered a massive amount of tightening and further aggressive action could harm the economy and spark a mortgage crisis. Mortgages in arrears increased 28.8 y/y in Q2, according to this week's report by the FCA.^[1]

Today's GDP release offered a negative surprise and played into those fears, since the economy contracted by 0.5% in July, the most this year. Testifying in the Parliament last week, Governor Bailey said that policymakers "are much nearer now to the top of the cycle", indicating that the end of the road is close. ^[2]

On the other hand, inflation is still high and despite expecting it to "fall significantly further" this year, the BoE does not see a fall below the 2% for nearly another two years ^[3]. At the same time, historically high pay growth feeds a wage-price spiral. Yesterday's report showed further increase in weekly earnings to 8.5%, which keeps pressure on the central bank for more tightening.

The Bank of England and the ECB both are due for pivotal rates decisions that will determine the pair's trajectory. The UK central bank announces its latest policy decision next week, but the European Central Bank precedes it, with Thursday's announcement.

European policymakers are also in tough place, since inflation is coming down, but is still far from target. At the same time, the economy is underperforming, with Germany not having grown since Q3 2022. President Lagarde had opened the door to a pause and there is uncertainty around the outcome.

EUR/GBP reacted higher as a result of today's GDP contraction and the potential monetary policy implications. It extends last week's advance and runs a positive month. The pair has returned above the EMA200, which puts 0.8702 in its crosshairs, but we are cautious around sustained strength. On the other hand, its previous visits above the EMA200 have proven short-lived and there is still risk for 2023 lows (0.8491).