Although the Euro has managed to gain ground in recent weeks amid positive fundamental signs and show other improvements in economic metrics, the pressure on the Pound has been unrelenting due to mounting negative reports from the United Kingdom’s Office for National Statistics. However, while the Pound has been beaten up over the last few months, there are several far-reaching factors that could quickly reverse that momentum. With an impending decision from the Bank of England Monetary Policy Committee rapidly approaching and speculation of expanded asset purchases from the European Central Bank gaining traction, the Euro may soon find itself giving back much of the recent rally higher. Even though the BoE is not expected to act, a deepening divergence in the regions’ respective policies could driver a deeper wedge between the currencies.

Fundamentally Speaking

Since the depths of the sovereign debt crisis, European monetary policy has undergone substantial upheaval as policymakers work desperately to restore inflation and keep the bloc competitive globally. The already dramatic moves by the European Central Bank to move deposit rates into negative territory combined with asset purchases have influenced some positive changes in the region, namely keeping inflation from slipping into deflationary territory and improved lending conditions. But the most important byproduct was the expansion of the monetary base and parallel depreciation in the common currency which has improved export competitiveness at a critical juncture when the export economy is shrinking. However, staying relevant and keeping the Euro cheap will likely be challenging considering ongoing efforts by other major economies to keep currencies competitive.

Still dragging on the Euro Area’s economy is the lack of fiscal stimulus measures from regional governments. The fragmented nature of the states and individual fiscal policies ensure that monetary policy is the only driver of recovery. However, the menacing nature of deflation and worsening external conditions are adding to the probability of an expansion of purchases at the ECB’s next meeting in March, potentially to the tune of €15-20 billion per month on top of an existing €60 billion. By comparison, the Bank of England has kept policy unchanged for years on end, opting not to add additional bond purchases after the first £375 billion or raise rates off of 0.50% since dropping them to record lows.