Sterling firmest vs euro since December on signs European inflation cooling

Sterling hit a 5-1/2 month high against the euro on Wednesday after data showing lower inflation in major European markets, but fell against the dollar as investors eyed Bank of England rate expectations for the pound’s direction.

The euro dropped to as low as 86.27 pence, its weakest since Dec. 15, and was last trading down 0.2% at 86.32 pence after inflation data from France and several major German states came in under expectations.

That caused European yields to fall and the euro to drop 0.6% against the dollar to a two-month low [GVD/EUR]

Versus the dollar, the pound was down 0.44% at $1.23585 as the U.S. currency benefited across the board from market jitters after poor Chinese economic data sent investors seeking the safety of the greenback.

The pound was also dragged lower in the slipstream of the euro.

More broadly, investors were looking at expectations for the Bank of England’s main interest rate for indications about where the pound trades from here.

“Compared to where we were last week, we’ve seen almost a full rate hike come out of the expectations for the terminal rate, that’s a big shift,” said Nick Rees, FX market analyst at Monex Europe.

“This reversal has actually been positive for sterling, which is the opposite of the way we would normally think of it. If you have another three or four rate hikes, that puts the UK into recession, which would weigh on sterling more than the positive benefits of the extra carry.”

He said this move had provided a boost for sterling against the euro, and put a floor under sterling against the dollar.

The euro is down around 1.5% against the pound in May, which would be the biggest monthly decline since October.