Potential EUR/GBP Reaction to the EU CPI

With the ECB having an open debate on how much more hiking is needed, investors will look closely at June CPI figures to see if Europe will have a similar problem to the UK.

The UK-like Problem: BOE Lagged

Last week, the BOE was forced to double the rate hike after inflation came in faster than expected. While the bank has been in the rate-hiking game the longest in this cycle, it has been more hesitant to tighten than other banks. On the other hand, the ECB was late to get into the hiking game after other central banks had already started tightening. Notably, the source of inflation in the UK is similar to Europe's: the consequences of the war in Ukraine after an extended period of government spending. With both sides of the English channel acknowledging that inflation has moved on to second-level effects and both central banks having a majority in favour of hiking but dovish dissenters, there are some worrying similarities.

Those worrying similarities also appear in forecasts for the Eurozone CPI figures, expected to be released on Friday. Headline Eurozone flash June CPI is expected to fall to 5.6%, but the core rate is expected to accelerate to 5.4% from 5.3% prior. There has been debate among ECB officials on how much to consider core inflation over headline inflation, and not surprisingly, the doves want more emphasis on the headline number.

The Market Reaction Might Be Similar

Unlike the UK, Europe has fallen into a technical recession, with the last two quarters of GDP at -0.1%. Although tomorrow sees the final measure of the UK GDP, it's theoretically possible it could be revised lower by two decimal points and put the UK in the same position as Europe. But, that is seen as unlikely, and such an eventuality would likely shock the markets.

Slower economic growth in Europe gives the ECB less room to keep hiking at an accelerated rate like the BOE. But, the BOE's aggressive move last week led to the pound weakening because investors worried it would push the country into a recession. A surprise on the upside of Eurozone inflation could provoke a similar response, weakening the currency as ECB President Christine Lagarde most recently talked up the need for continued hiking. On the other hand, there is less worry about causing a recession when the economy is already in one. A miss on expectations could reignite hopes that the Eurozone is getting through its relatively soft landing and could rebound later in the year, counterintuitively strengthening the euro, particularly concerning the pound.

Double Bottom Offered Bounce

EURGBP daily formed a double bottom at 0.8550 after bulls repelled short bets, with the price bouncing towards 0.8700. Additional attempts may see the pair rise as high as 0.8748 but unlikely to 0.8891 unless the downward leg from 0.8991 reveals its end at the trough. The short-term resistance holding might enact another decline, breaking under the regional support and exposing 0.8350 on its descent. In the interim, 0.8400 and 0.8522 may offer some respite, if not a trend change.

Source: SpreadX / EURGBP

Key Takeaways

The BOE recently had to double-raise interest rates due to higher-than-expected inflation. Some similarities between the UK and the Eurozone regarding inflation and economic growth exist as both sides acknowledge the second-level effects of inflation and have a majority in favour of rate hikes but face dovish dissenters. However, Europe is experiencing slower economic growth and a technical recession, contrasting with the UK. Forecasts for Eurozone CPI suggest a fall in headline CPI but an acceleration in core inflation. A similar response to BOE's aftermath could be expected if there is an upside surprise in Eurozone inflation – the BOE's aggressive move weakened the pound. However, a miss on expectations could reignite hopes for the Eurozone's recovery and strengthen the euro against the pound.