EUR/GBP pulls back below 0.8700 amid broader Euro weakness

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The Euro (EUR) failed to hold above 0.8700 against the British Pound (GBP) on Friday and pulled back to session lows near 0.8685 in the early European session. The pair, however, remains on track to close its first positive week in two months, fuelled by the ECB-BoE policy divergence.

EUR/GBP fails to find acceptance above 0.8700 and dips to the 0.8690 area.
The pair is on track for its first weekly appreciation in the last two months.
ECB-BoE monetary policy divergence boosted the Euro on Thursday.

The Bank of England (BoE) left its Repo Rate unchanged at 3.75%, as widely expected, on Thursday, but in a closer-than-expected call, with four policymakers voting for a rate cut, instead of the two expected by the market.

Beyond that, the bank’s governor, Andrew Bailey, showed confidence that inflation will reach the 2% target sooner than expected, which suggests that more rate cuts are in the pipeline.

The European Central Bank left interest rates on hold as well, but President Christine Lagarde stuck to the message that monetary policy is in a “good place” and downplayed the risk to inflation from a strong Euro, hinting at steady interest rates for the foreseeable future. The Euro rallied nearly 0.7% on Thursday following the central bank decisions.

The pair is trimming some gains on Friday following downbeat German Industrial Production figures. Data released by Destatis showed that factory output fell 1.9% in December, well beyond the 0.3% consensus decline, and November’s figures have been revised down to a 0.2% growth, from previous estimations of a 0.8% increase.

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.