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EUR to GBP Exchange Rate Could Drop 8% on ECB Cut and BoE Hold

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Boris Johnson

The EUR to GBP exchange rate is trading slightly higher today, following the news that the UK inflation rate rose more than projected. However, this could change in the next few days.

UK annual inflation rose to 1.8% and beat the 1.6% expected. The reading is much higher than the 1.3% seen in December. The higher than expected inflation reading would usually have boosted the GBP against the Euro, as it implies that there is less need for the Bank of England to reduce interest rates. Instead, the British Pound softened.

The lack of progress in the EUR to GBP pair could be because the British Pound has outperformed since August last year as the UK economy improved, the uncertainty around the general election passed, and the formal withdrawal from the EU was triggered.

From the worst levels in ten years to the best ones in four years

The strength in the UK economy has taken the EUR to GBP rate from its highest levels since 2009 six months ago, to the strongest level since 2016.

The price is trading just above the 2019 low of 0.8273, and this low is aligned with the December 2016, and April 2017 lows. Beyond the 0.8273 level, the next support level is the May 2016 low of 0.7563, and it could be this level that traders try to target on a break to the 0.8273 level, and this would mark an 8.63% gain in the GBP.

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ECB to cut, and BoE to hold?

Supporting a potential down move in the EUR to GBP exchange rate is built on two legs, the ECB cutting rates, and the Bank of England holding interest rate steady. However, the question is how much of this is already priced into the market.

First, expectations of a rate cut by the ECB is being priced in. The reason for the bearish outlook is the low European inflation and the coronavirus’s economic impact on the EU export-oriented economy.

Banks like Credit Suisse are calling for a rate cut and a drop in the Markit PMI readings over the next few months. On Friday, Markit will update on the development of the German manufacturing sector for February, however, already earlier this week, we saw the German ZEW index declined more than expected by economists.

As for the UK economy, the GDP rate showed a contraction for November, yet as soon as the election was over, the PMIs started to gain, also, today we know that UK inflation has bounced back, and the unemployment rate remains low.

The change in the outlook for the Bank of England has been dramatic, and just one month ago, the interest rates markets projected with a 75% probability that the Bank of England would cut rates by 25 basis points at their March 26 meeting. Today, on February 19, the rate markets are only giving it an 8% chance. It could be that the news is already in the price of the EUR to GBP rate, but a break to the 0.8273, would suggest that it is not.

EUR to GBP Technical Analysis

From a technical analysis, perceive the EUR to GBP exchange rate has created a significant rectangle pattern since October 2016.  The difference between the lower and upper limit of this pair is almost 1014 pips, and a break to the lower barrier suggests that the price could trade as low as 0.7252. On the way to the pattern target of 0.7252, the May 2016 low stands in the way, and is the first natural low beyond the 2019 low of 0.8273, and should make a good target for most bullish GBP investors. However, on a failure of the EURGBP rate to break the 2019 low, we could see the exchange rate reach the 0.85 level.

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