Sterling set for biggest weekly gain since May versus euro

The pound strengthened slightly against the euro on Friday to hit a new four-month high, extending gains from the previous day after the Bank of England set out plans for how it would tighten monetary policy.

The central bank’s message after a policy meeting on Thursday was slightly hawkish: the monetary policy committee voted 7-1 to maintain the pace of its government bond-buying, even though it expects inflation to jump to 4.0% around the end of the year. But it also said that “some modest tightening” of monetary policy over its three-year forecast period was likely to be necessary.

Because the hawkish shift had been largely expected, sterling did not react significantly to the news. But analysts said that it helped to reinforce the currency’s strengthening trend.

The pound has been a strong performer in recent weeks as COVID-19 cases – while still high – have fallen and high vaccination rates have allowed the British government to lift most social-distancing rules.

At 1016 GMT on Friday, it was down 0.1% against a stronger dollar at $1.3912.

Versus the euro, it was up around 0.1% at 84.89 pence per euro, and around 0.5% stronger on the week as a whole – its biggest weekly gain since May. Earlier in the session, it touched 84.795 pence per euro, which was the pound’s strongest level in four months.

The central bank’s messaging “may be a small step for the BoE, but it is a giant leap compared to ECB communication,” wrote ING FX strategists in a client note.

“With the BoE’s finger now on the trigger – any better UK data could start to see some outsize reaction in GBP as BoE tightening expectations are brought forward.”

Rate futures suggested investors were pricing in a first 15 basis-point rise to take the BoE’s benchmark Bank Rate to 0.25% around May next year. Before Thursday’s announcement by the central bank, rate futures pointed to a hike in August 2022.

MUFG currency analyst Lee Hardman said the BoE’s hawkishness reflects optimism that the UK economy will recover strongly from COVID-19. He expects BoE and European Central Bank policy paths to diverge.

“We are maintaining a short EUR/GBP trade idea in anticipation that the pair will fall to fresh year-to-date lows.”

But Marshall Gittler, head of investment research at BDSwiss, said that the BoE’s “hawkish tilt” was no more than what was expected and tightening is not likely to be quick.

“There’s little reason for this announcement to boost the pound,” he said.

Currency markets were generally quiet ahead of U.S. employment data due later in the session. Traders expect strong numbers which could make the case for faster U.S. policy tightening.