EUR/GBP trades with caution near five-month low of 0.8620, ECB-BoE policy in focus

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The EUR/GBP pair trades vulnerably near the five-month low of 0.8620 during the early European trading session on Tuesday. The cross has come under pressure ahead of monetary policy announcements by both the European Central Bank (ECB) and the Bank of England (BoE) on Thursday.

EUR/GBP struggles to regain ground near 0.8620 in the countdown to the BoE-ECB monetary policy.
Both the BoE and the ECB are expected to leave interest rates unchanged.
Ahead of the ECB monetary policy, investors will focus on the flash Eurozone HICP data on Wednesday.

Investors expect both central banks to leave interest rates at their current levels. The ECB is seen holding its Deposit Facility Rate steady at 2% as inflation in the Eurozone region has remained close to the central bank’s 2% target.

Ahead of the ECB’s monetary policy announcement, investors will focus on the preliminary Eurozone Harmonized Index of Consumer Prices (HICP) data for January, which will be released on Wednesday. The headline HICP is expected to have risen at an annualized pace of 1.7%, slower than 1.9% in December. In the same period, the core HICP – which excludes volatile components like food, energy, alcohol, and tobacco – is estimated to have grown steadily by 2.3%.

Meanwhile, the BoE is seen leaving borrowing rates unchanged at 3.75% as the impact of previous interest rate cuts is yet to flow into the economy. Also, the United Kingdom (UK) central bank reduced interest rates by 25 basis points (bps) in the December policy meeting and reiterated that the monetary policy is on a “gradual downward path”.

A higher-than-projected increase in the UK Consumer Price Index (CPI) data for December is also expected to discourage BoE officials from delivering back-to-back interest rate cuts. In December, the headline inflation accelerated to 3.4% from 3.2% in November after slowing down for two months.

Central banks FAQs

What does a central bank do?

Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.

What does a central bank do when inflation undershoots or overshoots its projected target?

A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.

Who decides on monetary policy and interest rates?

A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.

Is there a president or head of a central bank?

Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.

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