EUR/GBP sets to extend downside to near 0.8750, UK Inflation hogs limelight

• EUR/GBP is at a make or a break level around 0.8772 ahead of the UK Inflation release.
• Considering the UK’s stubborn inflation, the Bank of England might hike interest rates further by 50 bps.
• European Central Bank might decelerate the pace of hiking interest rates led by declining energy prices.
• EUR/GBP is expected to continue its downside momentum to near 0.8750 after breaking the 0.8772 support.

The EUR/GBP pair is attempting to recover after dropping to near the crucial support around 0.8770 in the early European session. The cross has been declining dramatically after a surge in United Kingdom’s employment bills data has resulted in an upward revision in the inflation projections. This has also triggered the expectations of further policy tightening by the Bank of England (BoE), which is rigorously working to tame the stubborn inflation from its multi-decade high at 11.1%.

The cross delivered a bumper fall on Tuesday after the British Office for National Statistics provided the expression of a tight labor market and higher wage growth, which are sufficient to set inflation on fire in the United Kingdom economy. For further guidance, investors will be laser-focused on the release of the UK Consumer Price Index (CPI) data, which will release on Wednesday at 07:00 GMT.

Higher wage growth dampens BoE’s efforts of inflation softening

Bank of England Governor Andrew Bailey and other policymakers are putting their blood and sweat in decelerating the pace of soaring inflation for almost a year. Mammoth efforts from Bank of England policymakers by hiking interest rates have managed to trim the annual headline inflation from its multi-decade high of 11.1% to a mere 10.7%. Slowing energy prices in the UK economy have infused a sense of confidence in the Bank of England’s Bailey that the price index will start declining meaningfully. However, escalating wage inflation due to the holding of bargaining power by job-seekers to address labor shortage is creating troubles for the Bank of England policymakers.

Meanwhile, Financial Times reported that the post-Brexit UK economy is facing a shortfall of more than 300,000 workers as the result of ending the free movement of labor with the European Union.

Even UK inflation softening won’t trim BOE’s policy tightening pace

Going forward, the release of the UK Consumer Price Index (CPI) data will remain in focus. As per the consensus, the headline CPI inflation will soften by 10 basis points (bps) to 10.6% YoY figure versus 10.7% released for November while the Core CPI, which excludes volatile food and energy items, is likely to ramp further to 6.6% YoY during December, from 6.3% previous readouts. Regarding the monthly figures, the CPI is expected to remain steady at 0.4% amid softening energy prices.

On a broader note, escalating the wage price index might offset the impact of declining energy prices. This might keep the stubbornness of inflationary pressures intact and will force the Bank of England (BOE) to continue hiking interest rates. A note from ING states that "Depending on the resilience of December UK CPI data, it seems too early to dismiss the risk of another 50 basis points rate hike.”

Recession likely to be short in Eurozone

The Euro failed to find strength despite the release of the upbeat German ZEW Survey- Economic Sentiment data. The economic data was released at 16.9 vs. the expectation of -15.5 and the former release of -23.3. Declining energy prices and the inflation pace have improved investors' sentiment toward Eurozone prospects. Also, commentary from Germany’s Economy Minister Robert Habeck, that “if there is a recession, it would possibly be only very short and not very deep”, in an interview with WELT TV, has strengthened sentiment data.

Also, European Central Bank (ECB) board member and Bank of Portugal Governor Mario Centeno said on Tuesday, “Fourth quarter growth in Europe will be most likely still positive.”

Information that has weakened the shared currency bulls is the expectation of a slowdown in the pace of hiking interest rates by the European Central Bank. Bloomberg reported that European Central Bank policymakers are starting to consider a slower pace of interest-rate hikes after a likely 50 basis-point step in February. “The rapid energy-driven decline in headline inflation is giving the ECB a bit of breathing space, but policymakers will remain focused on persistent underlying pressures for now.

However, European Central Bank President Christine Lagarde indicated in December’s monetary policy meeting that the pace of hiking interest rates will be higher in CY2023.

EUR/GBP technical outlook

EUR/GBP demonstrated a vertical sell-off after a breakdown of the Head and Shoulder chart pattern formed on an hourly scale, which triggered volatility and resulted in a bearish reversal. The cross is expected to weaken further after breaking below the horizontal support plotted from December 16 high at 0.8772.

Downward-sloping 20-period Exponential Moving Average (EMA) at 0.8800 will continue to act as a barrier for the Euro. Also, an oscillation in the bearish range of 20.00-40.00 by the Relative Strength Index (RSI) (14) is indicating that the downside momentum is active.