There might only be 30 kilometers of sea water that separates the U.K. from continental Europe but the gulf between the policies of its two central banks has grown exponentially, leading currency analysts to believe an interesting trading opportunity could develop over the coming months.
The stubbornness of the euro has seen it trade in a tight range against sterling for the last six months, fluctuating between 0.84 and 0.82 against the U.K. pound. But now the European Central Bank (ECB) has revealed a belt and braces approach to tackling deflation fears, many analysts believe that there is only one way that trade is going.
“We think (EURGBP) could be the most interesting trades going forward,” Kathleen Brooks, a research director at FOREX.com told CNBC via email. “The Bank of England is expected to hike years before the ECB.”
The “currency cross” – a trade between two currencies that doesn’t include the U.S. dollar — wobbled slightly on Wednesday morning after the release of the minutes from the latest Bank of England policy meeting. Some market watchers had expected a dissenting voice at the bank but the document revealed a unanimous decision to keep its benchmark rate held at a record low of 0.5 percent.
The euro appreciated and traded at around 0.8011 against sterling but analysts said there was enough in the BoE minutes to suggest a rate hike could still be coming come this year.
Analysts at U.K.-based foreign exchange company World First predict a “gradual grind” lower through the year to a rate around 0.7875 for September. They also predict it’ll be one of the “most crowded” trades of the summer. FOREX.com believe it will hit 0.7755 in the next three months and could, get to 0.75 by year end, while strategists at UBS think it’ll be down to 0.78 by the beginning of September.
Societe Generale, meanwhile, believe the contrast between the ECB and the BoE is “incredibly striking.” The French bank’s analysts have told investors that the cross is much more appealing than trading sterling against the dollar, which is currently at five-year highs.
However, if investors need a reason not to jump head first into shorting the euro against the pound then a warning signal comes from the trading desks of Monex Europe. Eimear Daly, head of market analysis at the firm told CNBC via email that the most severe period of euro weakness, following the ECB’s unveiling of a series of policy measures in early June, is now over.
“Stabilizing euro zone money market rates and as well as ECB deposit levels means the initial bout of euro weakness is over,” she said.
“Unlike other analysts I don’t seem diverging monetary policy as the key driver of euro-sterling. Euro crosses have never traded on diverging central bank policy but on capital flows.”
She expects an increasingly hawkish Bank of England to have a limited impact on EURGBP trading and sees the downside risk limited to 0.78 with the “cross” likely to trade back to 0.82 by year end. Simon Smith, the head of research at FxPro would back up this thesis. Writing in a note last week that this currency cross could be the focus for many macro players during the second half of 2014 but warned that the downtrend has been established since April and “a fair deal has already been priced in.”