EUR / GBP probing yearly lows at 0.8385, affected by risk appetite and central bank policy divergence

• EUR / GBP fell below 0.8400 on Thursday and is testing yearly lows at 0.8380.
• The pair has been under selling pressure since last Monday due to better risk appetite and central bank divergence.
• Weakened trading conditions for the holiday mean that a sustained bearish breakout is unlikely this week, bears will look for a break below 0.8380 in 2022.

Despite tight liquidity conditions during the holidays in the world and European currency markets on New Year’s Eve, the EUR/GBP it has dropped below 0.8400 to test yearly lows at 0.8385. That translates into daily losses of approximately 0.3%. The pair has been under strong selling pressure since hitting highs last week at the 0.8550 area and, at current levels, is trading almost 2.0% lower from these highs. A surge in risk appetite amid a rush to discount the economic pessimism related to Omicron amid numerous studies showing the variant is much milder than previous strains has helped risk-sensitive GBP and has weighed heavily. on the EUR / GBP.

Meanwhile, the fact that the UK healthcare system has yet to show signs of being overwhelmed despite the rampant Omicron infection in the country means that UK policy makers have so far refrained from going back. to put England in lockdown. Before the recent surge in risk appetite, the UK had been seen as the epicenter of Omicron in Europe, a perception that weighed on the GBP at the time and contributed to the EUR / GBP hitting highs near 0.8600 early. of month.

Diminishing perceptions of risk posed to the UK economy’s short-term outlook by the rapid spread of Omicron has given the green light for currency markets to price in a more aggressive than expected BoE. Remember that at the beginning of the month, the bank surprised some market participants by raising interest rates by 15 basis points and stating that more will come in 2022. At that time, the British pound struggled to benefit as traders feared that the Bank England’s failure to meet expectations due to Ómicron disrupting the UK’s recovery. But now that pandemic risks are waning, central bank divergence may return as a key driver of the forex market in 2022.

As emphasized in the characteristically aggressive comment on Thursday from Klaas Knot (Dutch central bank director) and Robert Holzman (Austrian central bank director), the aggressive voter of the ECB’s policy-making, there is a healthy debate at the ECB about its timetable for the normalization of monetary policy. A growing crowd of policymakers seems concerned about the upside risks to the bank’s inflation forecast for 2023 and beyond (which currently foresees a drop in inflation below 2.0% to justify the ongoing stimulus). Recall that the bank decided that it would temporarily increase the pace of QE purchases under the pre-pandemic APP in the second and third quarters to offset the end of the PEPP at the end of the first quarter.

The bank said it would continue APP purchases for as long as necessary, but if inflation continues to surprise to the upside in 2022, it looks likely to be completed by the end of the year. A report on Spain’s December inflation, released Thursday, increases the risk of an upside surprise over next week’s estimate of December global inflation for the euro zone. This increases the likelihood of bullish surprises in 2022.

The ECB is clearly on the path to monetary policy normalization, as are other large central banks, but even if inflation surprises force it to roll back the stimulus at a faster pace, the bank remains far behind the BoE in this regard. Therefore, any possible aggressive pivot from the ECB may struggle to result in lasting EUR / GBP strength. While weakened trading conditions by the holidays mean that a sustained break down from the yearly lows at 0.8380 looks unlikely on Thursday or Friday, the level is vulnerable to breaking out in the new year.

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