EUR/GBP rebounds back above 0.8350 after printing fresh multi-year lows

• EUR/GBP has rebounded back above 0.8350 in recent trade and is flat on the day after hitting multi-year lows earlier.
• Many FX strategists continue to favour a lower EUR/GBP with the BoE/ECB policy divergence expected to widen further.

After hitting its lowest level since February 2020 earlier in the session at 0.8332 and, in doing so, marginally eclipsing the multi-year low it set last week at 0.8333, EUR/GBP has since rebounded back to the north of the 0.8350 level. As things stand, the pair is now back to trading flat on the day in the 0.8350s, with the bears likely to eye any retest of last week’s highs in the 0.8370 area as an opportunity to reload on short positions.

Indeed, shorting EUR/GBP has been a profitable strategy in recent weeks. Since 20 December, the pair has reversed more than 2.0% lower from around the 0.8550 mark, mainly as a result of fears surrounding the impact of the Omicron variant on the European and global economy subsiding. That’s evidence really started to compound in the week starting on 20 December that the new variant is far milder than anything seen before, resulting in the UK and other governments opting against lockdowns.

But sterling’s recent strength against the euro also likely reflects growing expectations of central bank divergence between the ECB and BoE. The UK government’s decision not to lockdown has kept the prospect of a second post-pandemic BoE rate hike in February alive. By contrast, the main debate at the ECB is currently about the appropriateness of its inflation forecast. Most recently, influential governing council member Isabel Schnabel said the ECB would need to act to curb inflation if it continued to surprise on the upside, joining a throng of others to espouse a similar view.

That implies that if the ECB is forced to upgrade its 2023 inflation forecast to substantially above 2.0% from its current 1.8%, then perhaps the central bank may axe its QE buying in 2022 and start tentatively hiking in 2023. Compare that to the BoE, which is seen implementing multiple rate hikes over the same timeframe to likely get the bank rate above 1.0%. The wide and growing divergence is one key reason why many FX strategists remain bearish on EUR/GBP and target an eventual retest of the late 2019/early 2020 lows under 0.8300.