Pound gains as euro zone outflows lift UK assets

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Pound gains as euro zone outflows lift UK assets

Highlights

Pound rises 0.1% to $1.34, outperforming amid expectations for at least three Bank of England rate hikes by April, compared to two from the ECB.
Sterling gains 0.3% against the U.S. dollar over the past month, while the euro drops 2%, with euro-sterling seeing the euro down 0.5% this week and 1.8% year-to-date.
Euro declines driven by euro zone asset outflows, French bond yields at 24-year highs, STOXX 600 down 1%, and options traders most negative on the euro since mid-2024.

Rate expectations and cross-market flows

As reported by Reuters, the pound is up 0.1% on the day at $1.34, making it one of the stronger performers alongside the Japanese yen and Swiss franc.

Money markets show traders expect the Bank of England to deliver at least three quarter-point rate hikes by April, with the first fully priced for the November 5 policy meeting. That compares with roughly two hikes expected from the European Central Bank, widening the rate differential that supports carry trades funded in euros and invested in higher-yielding currencies such as sterling.

Over the last month, sterling has been the best-performing major currency against the U.S. dollar, rising 0.3%, while the euro has been the weakest, down 2%. ING strategist Chris Turner says both independent sterling strength and independent euro weakness are driving the move in euro-sterling, with stronger market confidence in a Bank of England tightening cycle reinforcing the pound's appeal as a higher-carry European currency.

Pressure on the euro zone backdrop

Investor concern over high oil prices, the cost of the AI buildout and the ability of developed-market governments to reduce heavy debt burdens is unsettling riskier assets, especially in Europe. French bond yields rise to new 24-year highs and euro zone stocks fall sharply, while UK gilt yields are flat and the FTSE 100, though down 0.6%, outperforms the STOXX 600, which is down 1%.

The euro is heading for a fourth straight week of declines against the pound and has lost another 0.5% so far this week, taking its drop for the year to 1.8%. If that move holds, it would mark the euro's biggest monthly fall against sterling since May 2023.

Concerns over the French government's ability to repair its finances are also weighing on the single currency, while LSEG data shows options traders are the most negative on the euro against the pound since mid-2024. Markets are also watching UK finance minister John Healey's first budget on October 28, though major investors expect it to pass without seriously disturbing markets.

In our earlier article on Mario Draghi’s warning about the policy trade-off between inflation control and growth, we outlined how keeping rates above growth for too long can worsen debt dynamics and raise the risk of “fiscal dominance.” We also highlighted his argument that central banks should prioritize price stability while avoiding unnecessarily restrictive rate paths that could choke investment, alongside calls for EU-level measures to support productivity and AI-related investment.

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