The euro traded slightly higher against the British pound on Thursday, hovering near 0.8710 in early European dealings, as traders focused less on weak German data and more on a widening gap in monetary policy between the European Central Bank (ECB) and the Bank of England (BoE). Attention is now fixed on Germany’s Harmonized Index of Consumer Prices (HICP) release on Friday, seen as a potential catalyst for the next move in the currency pair.
Weak German output overshadowed by ECB stance
Germany’s statistics office reported that industrial production fell 0.3% month-on-month in February, defying expectations for a 0.9% rise. January’s figure was revised up to flat from an initial estimate of a 0.5% decline. On an annual basis, output was unchanged in February, after a 0.9% drop in January.
Despite the soft data, the euro held firm, with the single German data point overshadowed by expectations that the ECB will keep monetary policy tighter for longer than the BoE.
ECB seen tightening further as inflation stays high
The ECB has maintained a firm stance on inflation, with policymakers signaling that additional rate increases remain on the table if price pressures do not ease. Market pricing currently fully reflects two additional rate hikes by December and assigns more than a 50% probability to a third move before year-end.
Recent data support this hawkish tone. Eurostat’s flash estimate for March put headline inflation in the euro area at 5.9%, almost three times the ECB’s 2% target. Core inflation, which strips out volatile components, held at a record 5.7%, underlining the persistence of underlying price pressures.
Comments from multiple ECB Governing Council members in late March reinforced the message that there is limited scope to soften policy in the near term.
BoE tones down expectations for further rate hikes
In contrast, expectations for further rate hikes in the United Kingdom have cooled. Developments linked to ceasefire announcements earlier in the week helped ease some of the market’s perceived need for additional tightening.
BoE Governor Andrew Bailey cautioned that markets may have been too quick to price in more rate increases, stressing that prevailing conditions support leaving rates unchanged for now.
Adding to the cautious tone, the UK Office for National Statistics reported a 0.7% fall in retail sales volumes for February, pointing to weakening consumer demand and complicating the case for tighter policy. Markets are increasingly sensitive to any additional signs that the British economy is slowing faster than that of the euro area.
Policy divergence drives currency and asset reallocation
The growing divergence between the ECB and BoE outlooks has become the primary driver of currency valuations, with the ECB’s commitment to tackling inflation providing support for the euro despite evidence of economic softness in Germany.
This policy split is also prompting reassessment in broader markets. A continued tightening of financial conditions in the euro area could encourage a rotation away from highly volatile, non-yielding assets toward traditional interest-bearing government debt, which is becoming more attractive as rates rise.
All eyes on German inflation data
Market focus now turns to Friday’s release of Germany’s HICP data.
- A higher-than-expected reading would likely strengthen the case for further ECB rate hikes and could reinforce the current upward trend in the euro against the pound.
- A downside surprise in inflation could raise doubts about the pace of future policy tightening and introduce fresh volatility into both currency and rate markets.
For now, the euro’s modest gains against the pound reflect a market more guided by central bank trajectories than by a single weak industrial output print. Traders are positioning ahead of the German inflation release, which may set the tone for both currencies in the weeks ahead.
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