Nomura’s Global FX Strategy team, including Dominic Bunning and Yusuke Miyairi, argues that a more hawkish ECB path versus the Bank of England should support the Euro against the Pound. They keep a long EUR/GBP stance and see narrowing front-end rate differentials and UK political-fiscal risks as catalysts for a move in EUR/GBP towards 0.90 over the coming months.

Long EUR/GBP on ECB-BoE divergence

"Hawkish ECB announcements today, as well as potential rate hikes in the future will be EUR positive, in our view. We like to express this via long EUR/GBP, with the GBP leg likely to face adverse pressure due to political fiscal risks."

"We think there is room for EUR to outperform many of its peers as the ECB shows a more hawkish reaction function to upside price pressures. We have maintained a long EUR/GBP trade over recent months, and while the pair has not moved significantly against us, it has also been an incredibly frustrating position to hold, failing to break out to the topside despite a number of risks to GBP (especially on the political and fiscal front). However, we think the clearer signs of monetary policy divergence will ultimately drag the pair higher."

"EUR/GBP has a consistent relationship with front-end rate spreads, and with our new view of a terminal ECB rate of 3.00% versus a BoE rate of 3.50% in 2027 (one hike this year, two cuts next year), a narrowing of the 2y rate differential to below 100bp from 140bp would support a move in EUR/GBP towards 0.90 (Figure 4). Positioning data are mixed but do not suggest many impediments to a move higher in the cross."

"Political and fiscal risks persist for the UK, of course, ahead of the by-election on 18 June which currently seems likely to see Andy Burnham return as an MP and challenge PM Keir Starmer for the top job. The resignation of Defence Secretary John Healey on 11 June further undermines Starmer, but also points to an underlying truth that the fiscal backdrop in the UK is exceedingly tight and will require spending cuts or tax increases. We would think Burnham will favour the latter, weighing on growth further."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)