EUR/GBP dips back under 0.8350 as risk appetite firms, pound remains resilient to domestic political noise

• EUR/GBP recently slipped back under 0.8350 amid the ongoing rebound in US equities and macro risk appetite.
• Central bank divergence also continues to weigh while the pound remains resilient to political uncertainty.

EUR/GBP has been nudging back lower on Wednesday and recently dipped under the 0.8350 level, nearly 1.0% below Monday’s highs in the 0.8420 area and down a further 0.3% on the day. Macro sentiment has been unusually choppy this week with large swings seen in US equity markets. But sentiment is on a firmer footing this morning with S&P 500 futures about 1.4% up on the day to back in the green on the week and up about 4.5% versus earlier weekly lows ahead of Wednesday’s Fed meeting. This recovery in sentiment in stocks markets is translating into outperformance of risk-sensitive currencies in the G10 FX space, such as GBP.

Couple the recovery in risk appetite with ongoing bets that the ECB will lag the BoE by a substantial margin when it comes to monetary policy normalisation and it perhaps unsurprising to see EUR/GBP come under pressure. All signs, including recent upside inflation and labour market data surprises and business surveys that have highlighted inflationary/tight labour market concerns, point to the BoE hiking interest rates again next week (to 0.5% from 0.25%). Indeed, the British public’s 12-month inflation expectation hit a record high of 4.8% in January according to the latest YouGov/Citi poll. Citi economists said the data “suggest elevated risk inflation expectations could become de-anchored to the upside as inflation accelerates in the months ahead”.

Contrast that with remarks from ECB policymaker and Lithuanian Central Bank Governor Gediminas Simkus on Wednesday. He reiterated the central bank’s central viewpoint/stance that the inflation outlook is not a reason to change the path of policy and that there is no evidence of the need for a significant change to the bank’s forecasts. EUR/GBP bears are thus likely to remain confident in their forecasts that late-2019/early-2020 lows in the 0.8280s are will be hit sooner or later, as sterling continues to shrug off domestic political risk.

For reference, UK PM Boris Johnson appears on the verge of losing his job as the “partygate” scandal escalates (London police are now investigating Downing Street lockdown breaches). Much will depend on the highly anticipated Sue Gray report, which will be handed to the PM on Wednesday and apparently will not be good news for the PM. “While most Tory MPs have pledged to wait for the result of the investigations before moving to vote out Johnson, there now appears more consensus that the PM's tenure is close to its end,” said analysts at ING. “Chancellor Rishi Sunak is currently seen as the most likely candidate to take over the role as PM”. “Given no obvious implications for the UK economy or the Brexit stance for the moment, any change at the helm of the government should have a limited impact on the pound” they add.