EUR/GBP outlook: Getting carried away

This currency pair has had a torrid start to 2024 and is down 1.7% YTD. The euro has generally had a tough start to the year, as investors sold the single currency. A mixture of weak economic data from the currency bloc, especially its biggest economy, Germany, has not helped the performance of the euro.

German industrial production dropped by 1.6% in December 2023, it is down 3% compared to 2022, and it is still 10% below its pre-pandemic level. Germany is considered the world’s industrial powerhouse, yet a mixture of cyclical and structural factors is weighing heavily on this economy. Germany is now expected to have the weakest GDP growth in the Euro area for both 2024 and 2025.

Growth rates matter for currency crosses like EUR/GBP, and it is worth noting that the UK is expected to see stronger growth rates than the Eurozone in both 2024 and 2025, according to the latest OECD forecasts. While the difference is small, compared to recent years when the UK has underperformed its European counterparts, this is an important shift for the UK economy, and for GBP.

The weaker growth outlook for the Eurozone is also impacting interest rate expectations for the currency bloc. Relative interest rate differentials and the carry trade, are a key driver of currency markets. Financial markets are currently expecting the ECB to cut rates more than 5 times this year, in the UK the BOE is only expected to cut rates 3.5 times. By the end of the year, the UK’s interest rate is expected to be 1.7% higher than the Eurozone’s interest rate, and this is boosting GBP vs. EUR. This is also one reason why GBP has risen by 1.67% vs. the EUR since the start of 2024 and is the best performing currency vs. the EUR compared to the rest of the G10 FX space.

There is some evidence to suggest that the weaker euro is also a reflection of economic woes in China, due to the importance of China as a trading partner to the Eurozone. Thus, we may not see a meaningful recovery in the euro until we see China’s growth rates pick up. Right now, the market remains fairly bearish on the outlook for China this year.

From a technical perspective, EUR/GBP is approaching a key technical support level – the low from 11th July 2023. We will be watching this level closely, if EUR/GBP does fall below the 0.8500 level then it could open the door to a deeper decline towards 0.8250.