In our FX review this week, we discuss the impact of the ECB meeting on EUR pairs, why the USD has become range bound and what could be in store for GBP given the expectations of a looming interest rate hike.

EUR back in focus

It’s been a while since the Euro was the main focus for market participants. For most of the past year, the ECB have been rather boring to listen to. No changes in policy have been announced, and certainly no prospect of raising interest rates has been on the table. As a reminder, the Eurozone is one of the few places where negative deposit rates (-0.5%) currently exist. 

What usually occurs is that investors use the Euro as a funding currency to express a view on another currency. For example, if I thought GBP was likely to appreciate in value over the past month due to rising interest rate expectations, I could sell EUR and buy GBP. The benefit of this is that due to low (negative) rates, my cost of financing in EUR is very cheap. This allows the focus to be on the currency I buy. Added to this is a positive cost of carry. What this means is that I borrow at -0.5% but earn 0.1% from holding GBP. So I actually profit from holding the position through the interest rate differentials.

So what did we learn from the ECB meeting on Thursday? Well it appears that the pandemic purchase program (PEPP) could be extended past the current deadline of next March. A decision on this next month is likely. President Lagarde also pushed back on any expectations of a rate hike anytime soon, particularly as she still sees the high inflation as temporary. 

The latest reading of Eurozone inflation for October was 4.1%, the highest since the GFC. 

Bottom line here is that the ECB are unlikely to provide any spark for the Euro in coming months, so we would continue to favour it as funding currency for other ideas.

USD range bound, GBP eyed

 Through most of the week, we didn’t see USD crosses take any meaningful move, with UST’s also not that volatile. On Friday we did see a strong bid in the USD, although we flag this up as to do with month end flows rather than anything too serious. However, it did push both EURUSD and GBPUSD to bearish 4hr candles to close the week, taking all of the momentum for a push higher out of the equation for EUR and GBP.

While talking about GBP, we look ahead to the Bank of England meeting next Thursday. We think that the Bank will raise interest rates by 0.15% to put rates back at 0.25%. It’s hard to tell how much of this is already priced into GBP, we estimate around a 75% figure. Therefore, although we could see a knee jerk bid higher in GBP crosses next Thursday, we wouldn’t chase any rate hike higher. After all, high Covid-19 infection rates could cause problems for the currency again.

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