Pound to Euro: Sterling Downside Likely Limited From Here says HSBC Strategist

The British Pound’s retreat from July highs against the Euro and Dollar could slow from here with one analyst saying the Bank of England’s August policy decision and guidance had enough ‘hawkish’ elements to limit the prospect of further downside.

The Bank opted to raise rates by 25 basis points as it pulled back from June’s outsized 50 basis point hike, in a decision that triggered a kneejerk selloff in Pound Sterling.

“The decision did represent a somewhat dovish outcome, but there were still some elements of hawkishness in the vote split, the statement, and the forecasts,” says Dominic Bunning, Head of European FX Research at HSBC (LON:HSBA).

These elements include the two votes for a 50bp hike, by Catherine Mann and Jonathan Haskell, and the statement retaining the line that a “further tightening of monetary policy would be required” if there was evidence inflation was more persistent.

“On top of this, the BoE’s forecasts for inflation for 2025 increased compared to May’s monetary policy report, despite the new forecasts being predicated on higher rates than those used in May’s projections,” says Bunning.

Declines in Pound Sterling and UK bond yields over recent days reflect the market’s steady reduction in expectations for the peak in Bank Rate, falling to just below 5.75% in the wake of the decision.

But expectations ultimately steadied as investors grasped the ‘hawkish’ elements of the day.

Governor Andrew Bailey was keen to point out in the post-decision press appearance that the strength of the labour market remains a factor that can keep inflationary rates elevated for an extended period.

“The committee also flagged how strong pay growth created an ongoing risk of persistent inflation. This suggests the BoE retains a modest tightening bias, especially compared to the more explicitly data-dependent Fed and ECB,” notes Bunning.

The Pound to Euro exchange rate fell as low as 1.1556 in the wake of the Bank’s decision, before paring the advance back to 1.1620 on Friday, suggesting Sterling’s ship steadied somewhat as traders grasped the full implications of the guidance.

“We have argued that GBP was looking stretched on the upside in mid-July and have expressed a tactically bearish view on the currency versus NOK in recent weeks. But some of the hawkish elements below the surface of today’s decision may limit excessive downside in the currency from here,” says Bunning.