The pound rose against the euro, thanks in part to higher UK interest rates

Analysis – The pound has gradually risen against the euro for several months. The value of the coin is nearly 10 percent over the past year and a half. The main reason for this increase is the widening interest rate differential between the UK and the Eurozone. This makes it increasingly attractive for parties to hold the capital in pounds.

While interest rates in the Eurozone have remained at a very low level since 2019, the Bank of England actually started raising rates at the end of last year.

Last Thursday, the Bank of England raised its official interest rate for the third time in a few months. Remarkably, the pound fell slightly in the foreign exchange markets on that day. The interest rate hike appears to have faded.

One important reason for this is that the European Central Bank (ECB) took lead a week ago in raising interest rates faster than the currency markets had expected. With that said, the pound’s decline looks more like a breather than a trend reversal. It is not certain whether the European Central Bank is really ready to step in in a significant interest rate brake and thus also jeopardize the economic recovery.

In addition, the UK is less dependent on oil and natural gas than Russia than the Eurozone. But it is the trade talks that could create new tailwinds for the pound.

A free trade agreement with New Zealand was signed at the end of February. The British government expects that eliminating tariffs and rules on imports could increase two-way trade by 60 per cent.

A similar agreement was concluded with Australia. Negotiations for a trade deal with the United States begin in Baltimore next week. A second round of negotiations is scheduled for the spring.

The good trade relationship with the United States has been one of the spearheads for those in favor of Brexit. The value of the flow of goods and services between the two countries is approximately 240 billion euros annually. A trade agreement with the United States would be very welcome.

The pound may strengthen against the euro

The growth of the British economy is severely hampered by all kinds of shortages in supply chains. Many foreign workers have returned to their home countries. Shortages in the truck sector and meat processing companies are leading to supply problems and culling of livestock that were intended for slaughter.

The shortage is also causing the prices of all kinds of goods and services to rise in the UK. During the spring, inflation may rise to more than 8 percent.

If the BoE continues to work harder than the ECB to contain inflation and if trade talks with the US go well, things look good for the GBP.

Joost Derks is a currency specialist at iBanFirst. He has more than twenty years of experience in the currency world.