Euro To Pound Forecast: GBP Gains Could Reverse As UK Fiscal Risks Grow

The Pound has remained surprisingly resilient in recent weeks, but Rabobank believes Sterling is increasingly vulnerable to a reversal as investors reassess UK fiscal risks and Bank of England rate expectations.

EUR/GBP traded near 0.8641 on Thursday, close to its lowest levels since early April, with the Pound supported by rising UK interest rate expectations and relatively firm domestic data.

Rabobank said Sterling has been one of the strongest-performing major currencies since the Iran conflict escalated, largely because markets dramatically repriced the outlook for UK interest rates.

However, the bank believes investors have moved too far.

“The market is still pricing in too much policy tightening from the BoE,” Rabobank said.

Markets had previously swung from expecting Bank of England rate cuts this year to pricing as many as four hikes. Although some of those expectations have already been scaled back, investors still see scope for around three hikes over the next year.

Rabobank argues that outlook is unrealistic given weakening UK growth and a loosening labour market.

The bank warned that sharply higher rates would risk deepening economic weakness, particularly as Britain already faces sluggish growth, elevated debt levels and rising borrowing costs.

UK government bonds have come under heavy pressure in recent weeks, with 30-year gilt yields briefly touching their highest levels since 1998.

“It is certainly not good for the UK Chancellor or the tax paying public to hear that borrowing costs have reached multi-decade highs,” Rabobank said.

Political risks are also moving back into focus ahead of local elections in England and parliamentary elections in Wales and Scotland.

Labour is widely expected to suffer losses, potentially increasing pressure on Prime Minister Keir Starmer and fuelling speculation about a leadership challenge.

Rabobank noted that markets are becoming increasingly concerned about the possibility of a shift towards more left-leaning fiscal policies if Labour leadership tensions intensify.

“With the UK market dependent on the ‘kindness of strangers’ due to the current account deficit, GBP would inevitably be caught in the cross winds,” the bank warned.

While rising UK yields have helped support Sterling in the short term, Rabobank expects that support to fade as markets eventually reprice towards fewer Bank of England hikes.

Key Takeaway:

The bank’s central view is that the EUR/GBP exchange rate will gradually move higher over the next nine to twelve months as UK fiscal concerns and softer rate expectations weigh on the Pound Sterling.