– Written by
David Woodsmith
STORY LINK Pound to Euro Exchange Rate Slides towards 1.16 on Gilt-Market Stress
The Pound to Euro (GBP/EUR) exchange rate remained under sustained pressure at the end of the week and slipped towards 1.1610, its weakest level in almost three months.
The pair had attempted to stabilise around 1.1625 earlier in the week, but Sterling struggled as investors continued to question whether high UK interest rates would ultimately provide currency support or simply deepen concerns over the government’s fiscal position.
Key support remains around the 1.1600 area.
A decisive break below this level would represent a further deterioration in the short-term technical picture and increase the risk of deeper losses.
Bond markets remain an important source of uncertainty.
The UK 10-year gilt yield surged above 5.40% during the week and reached fresh 19-year highs, while German and French borrowing costs also moved sharply higher.
High yields can offer support to Sterling through improved carry returns, but the latest move has increasingly been associated with fiscal stress rather than economic strength.
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Higher borrowing costs will increase government debt-interest payments and add to the difficulties facing Chancellor John Healey ahead of the October 28 Budget.
Those concerns were reinforced by the latest government borrowing figures.
Public-sector borrowing reached £18.3bn in August, well above expectations of £15.5bn.
Borrowing for the financial year to date climbed to £77.3bn, £8.1bn above the Office for Budget Responsibility’s forecast.
BoE Rate Expectations Offer Limited Pound Protection
Bank of England policymakers also continue to warn that persistent energy pressures could require tighter monetary policy.
MPC member Clare Lombardelli commented; “The longer higher energy prices persist, the greater the risk that indirect effects build and that inflation expectations, wage bargaining and price-setting behaviour begin to adjust in response.”
She added; “On that basis, policy is increasingly likely to need to tighten if elevated energy prices persist, absent clear evidence of disinflation or weaker activity.”
Markets continue to price substantial Bank of England tightening over the coming year, although investment banks remain divided over whether policymakers will ultimately deliver the number of rate increases implied by the curve.
That uncertainty is limiting the Pound’s ability to benefit from higher yields.
Friday’s market pricing implied around 35 basis points of additional BoE tightening before the end of 2026 and more than 100 basis points by the end of 2027.
ING remains sceptical that the Bank will ultimately tighten as aggressively as markets expect.
The risk for Sterling is that a reassessment of those expectations removes one of the currency’s main sources of support.
German Resilience Supports Euro
The Euro has also benefited from relatively encouraging German economic data.
The Ifo business confidence index strengthened to 89.9 in September from 88.8 previously, exceeding consensus expectations.
There were improvements in both the current-conditions and expectations components.
ING commented; “Almost secretly, the German economy has developed unexpected resilience, with its leading indicator, the Ifo index, now up for the fifth consecutive month.”
Germany’s leading economic institutes also upgraded their 2026 growth forecast to 1.3% from 0.6%, providing further evidence that Europe’s largest economy has weathered the energy shock better than initially feared.
The outlook is far from clear-cut, however.
ING cautioned; “The German economy may have weathered the first half of the year better than expected, but past performance is no guarantee of future success.”
Fiscal pressures elsewhere in the Euro area also remain substantial.
France’s government debt is expected to reach almost 120% of GDP this year, while the spread between French and German government borrowing costs has widened to levels last seen during the Eurozone debt crisis.
Political divisions over France’s 2027 Budget are likely to keep this issue in focus.
For GBP/EUR, 1.1600 is now the immediate downside level to watch.
A sustained break would expose the July lows below this area and increase the risk of further losses.
Pound Sterling would need to regain 1.1650 initially and then 1.1700 to ease the current downward pressure.
The combination of UK fiscal concerns, stretched gilt yields and relatively resilient German data leaves the Pound vulnerable against the Euro.
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TAGS: Pound Euro Forecasts
