Sterling has
strengthened against the euro as expectations of higher UK interest rates
collide with growing uncertainty across European financial markets. On October
20, the pound reached its strongest level against the single currency since May
2025, with the exchange rate trading around 83.95 pence per euro (after a low
at around 83.89). The currency was mostly supported by UK labour-market data
that reinforced expectations of a Bank of England (BoE) rate increase on
November 5.
EUR/GBP
Daily Chart – Source: TradingView
However, the pound’s
advance is not simply a reflection of improving UK economic fundamentals.
Political unrest in France, rising European sovereign borrowing costs and
surging energy prices are also shaping currency markets. With money markets
almost fully pricing in a 25-basis-point BoE rate hike, the key question is
whether sterling can extend its gains or whether expectations have already gone
too far.
BoE Rate-Hike
Expectations Support Sterling, but the Labour Market Sends Mixed Signals
The latest UK
employment figures have strengthened the case for monetary tightening, although
they do not provide an unequivocal signal that the economy can withstand a
prolonged cycle of rate increases.
Annual growth in
regular wages reached 3.7% in the three months to August, exceeding economists’
expectations of 3.6%. The unemployment rate also edged down to 4.7%, its lowest
level since mid-2025, while preliminary payroll estimates suggested that employment
conditions may be stabilising. These developments followed a run of
stronger-than-expected UK economic data.
Employment Rate and Wage Growth in the UK – Source: Reuters
For the BoE, the
combination matters because persistent wage growth can contribute to domestic
inflation, particularly if labour costs remain elevated. If policymakers
believe that inflation will stay above their 2% target for longer than
expected, tighter monetary policy may be necessary.
Markets have responded
accordingly. Money-market futures were almost fully pricing in a 25-basis-point
increase at the November 5 meeting, which would lift the Bank Rate from 3.75%
to 4%. Investors were also anticipating further increases into 2027, although
expectations for a sustained tightening cycle remain less certain.
Higher expected UK
interest rates can support sterling by improving the relative return available
on pound-denominated assets. However, the latest employment report contains an
important counterpoint.
The number of
vacancies fell to 691,000 in the July-to-September period, its lowest level
outside the pandemic era since 2014. The decline suggests that businesses,
particularly smaller firms facing higher employment costs, remain reluctant to
recruit. The Office
for National Statistics also reported that payroll employment remained
weaker than a year earlier.
This creates a gap
between market expectations and the underlying economic picture. Wage growth
and falling unemployment strengthen the argument for a November rate increase,
but declining vacancies point to fragile labour demand.
The data therefore
provide a stronger case for a possible near-term hike than for assuming that
several additional increases will necessarily follow. If the BoE raises rates
as expected but signals caution about subsequent decisions, some of sterling’s
monetary-policy support could fade.
European Political
Turmoil Adds to the Euro’s Vulnerability
Sterling is also
benefiting from pressure on the euro, as investors reassess the political and
fiscal outlook across Europe.
France has become a
particular source of concern. Renewed demonstrations and unrest have added to
uncertainty surrounding the government’s ability to pass its 2027 budget and
address the country’s sizeable deficit. At the same time, French government bond
yields have approached levels last seen in 2002, while the spread between
French and German 10-year yields has widened significantly.
These developments
matter for the single currency because persistent sovereign bond-market stress
can undermine confidence in the eurozone’s economic and financial stability. If
investors begin to demand higher risk premiums across several member states,
concerns about financial fragmentation could intensify. Of course, France’s
difficulties should not be treated as an automatic signal of a wider eurozone
crisis. The implications for the single currency will depend on whether
political and fiscal pressures remain concentrated in France or spread to other
European markets.
For the GBP/EUR, the
distinction is important. Sterling can appreciate because investors become more
confident in the UK outlook, because they become less confident in the
eurozone, or through a combination of both.
The Oil Shock Could
Complicate the BoE’s Next Move
The Middle East
conflict introduces another variable that could reshape the outlook for
sterling and the euro: energy prices.
Brent crude climbed
above $111 per barrel on October 20, reaching its highest level since May, amid
persistent disruption risks around the Strait of Hormuz and limited progress
towards ending the conflict. The prospect of further interruptions to energy
shipments has kept markets concerned about supply and inflation.
Daily UK Oil Chart – Source: ActivTrades
For the UK, higher oil
and gas prices could push inflation higher through transport, household energy
bills and business costs. If these pressures persist, the BoE may face greater
difficulty bringing inflation back towards its 2% target, strengthening the
argument for higher interest rates.
That could initially
support sterling, particularly if investors expect the BoE to tighten policy
more aggressively than the European Central Bank (ECB). Yet the relationship
between energy prices, interest rates and currencies is not straightforward.
Higher energy costs
also reduce households’ disposable income, squeeze corporate margins and
potentially weaken economic growth. If the shock becomes sufficiently severe,
markets could begin to question whether further monetary tightening would
damage the UK economy rather than simply contain inflation.
The BoE has already
warned that prolonged energy-price volatility could make inflation more
persistent and increase the likelihood of further tightening. Its September
decision left Bank Rate at 3.75%, while acknowledging the risks arising from
the conflict. The ECB faces a similar dilemma, although the consequences
differ according to each economy’s exposure to energy imports, inflation
dynamics and fiscal position.
The key risk for
sterling is therefore that the energy shock initially supports rate-hike
expectations but eventually undermines the growth outlook. If markets begin to
focus more heavily on the economic damage, the pound could lose some of its
current advantage.
Can GBP/EUR Extend Its
Rally?
The outlook for the
GBP/EUR will depend on whether the BoE delivers the expected rate increase and
how policymakers assess the risks beyond November. Three scenarios stand out.
Sterling could extend
its gains if UK inflation remains persistent, the BoE raises rates and French
political uncertainty continues to weigh on the euro. A further widening in
expected UK-eurozone interest-rate differentials could provide additional support,
although much will depend on how much tightening is already reflected in market
prices.
The currency pair
could consolidate if the November hike is delivered but the BoE signals that
subsequent decisions will depend on incoming data. With vacancies falling and
hiring demand remaining weak, policymakers may be reluctant to validate
expectations of a prolonged series of increases. If European market tensions
also ease, sterling’s relative advantage could diminish.
The euro could recover
if energy prices retreat, political risks in Europe subside or markets reassess
the expected pace of UK monetary tightening. A deterioration in British growth
prospects could also undermine sterling, particularly if higher energy costs
squeeze household spending and corporate profitability.
For traders, the
distinction between the expected November decision and the outlook for rates in
2027 is important. A widely anticipated rate increase may provide limited
additional support if it is already priced into the GBP/EUR evolution. Future
price movements could depend more on the BoE’s guidance, inflation data and
developments in the Middle East.
Sources: Reuters, The Wall Street Journal, ONS, Bank
of England, Yahoo Finance
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