EUR/GBP remains below 0.8450, downside seems limited due to less dovish ECB

• EUR/GBP may appreciate as higher Eurozone inflation has bolstered chances of the ECB adopting a cautious approach to rate cuts.
• The ECB has emphasized that inflationary pressures remain high, driven mainly by wage growth.
• The UK’s Office for Business Responsibility has raised its 2024 inflation forecast to 2.5%, up from March estimates of 2.2%.

EUR/GBP inches lower after two days of gains, trading around 0.8430 during the early European hours on Friday. This downside of the EUR/GBP cross could be limited as unexpected increase in Eurozone inflation has bolstered expectations that the European Central Bank (ECB) will maintain a cautious approach to rate cuts, steering clear of significant reductions.

The preliminary Eurozone Harmonized Index of Consumer Prices increased to 2.0% year-over-year in October, up from the previous 1.7% reading and surpassing forecasts of 1.9%. The core inflation rate held steady at 2.7% year-over-year. This rise in inflation is supported by stronger-than-anticipated economic growth, with the Eurozone economy expanding by 0.4% quarter-on-quarter in Q3, twice the growth seen in Q2 and exceeding predictions of 0.2%.

The ECB has highlighted that inflationary pressures remain elevated, primarily due to wage growth. In its recent October meeting, the ECB reaffirmed its commitment to a "data-dependent and meeting-by-meeting" strategy for future policy decisions.

The Pound Sterling (GBP) lost ground since the UK Labour government’s first budget announced £40 billion in tax hikes aimed at reducing public finance gaps and bolstering public services, as reported by CNBC.

The UK’s Office for Business Responsibility (OCR) has revised its 2024 inflation forecast upward to 2.5%, from the previous estimate of 2.2% in March. This adjustment has also led traders to anticipate fewer interest rate cuts by the Bank of England (BoE).

Interest rates FAQs

What are interest rates?

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.

How do interest rates impact currencies?

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.

How do interest rates influence the price of Gold?

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.

What is the Fed Funds rate?

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.