GBP/EUR in 2023

WILL STERLING BE ABLE TO RECOVER THROUGH 2023, OR ARE FURTHER LOSSES IN STORE?

JOS É ALMEIDA GIVES A VIEW

THE POUND-EURO exchange rate declined last year as the UK suffered political upheaval and slipped into recession. Meanwhile, Central Bank policy decisions, the Russia-Ukraine war and surging energy costs all added to heightened volatility.

Here we look at the key things that could affect the pound-euro pair this year to explore how GBP/EUR might move in 2023.

UK and Eurozone recessions

As the UK’s economic situation worsens, we could see Sterling slip against the common currency. The Eurozone is also forecast to suffer a recession this year. However, it’s expected to be much milder than the UK’s. Forecasts from Consensus Economics see UK GDP contracting by 1% this year, compared to a 0.1% contraction for the Eurozone.

If we see these predictions play out, the GBP/EUR exchange rate could head even lower. GBP and EUR investors will be keeping a close eye on economic data releases to gauge the severity of each recession. If the UK economy does begin to recover towards the end of the year, the pound may be able to recoup some losses.

Central Bank policy

Another factor that could push the pound-euro pair lower is the narrowing policy divergence between the Bank of England (BoE) and the European Central Bank (ECB).

The BoE was one of the first major central banks to begin raising interest rates in response to surging inflation. Now, however, the BoE seems close to ending its tightening cycle – not wanting to raise rates too high as this could deepen and prolong the UK’s recession.

Meanwhile, the ECB was slower off the mark but is now making up for it with steep rate hikes and promises of more to come. At the time of writing, the ECB’s refinancing rate is one percentage point lower than the BoE’s Bank Rate. But with the ECB signalling at least two more consecutive 50bps hikes, and the BoE seemingly close to pausing, the European Central Bank could catch up.

Higher interest rates often boost the respective currency as they attract foreign investors seeking a higher return. As a result, the euro would likely benefit if the gap between the

BoE and the ECB narrows further. If the BoE chooses to cut interest rates later this year in an attempt to boost growth, Sterling could face further headwinds.

Russia-Ukraine war

Russia’s invasion of Ukraine weighed heavily on both the pound and the euro, but more so on the euro, as the Eurozone is more geopolitically and economically exposed to fallout from the war. Any fresh escalations in the conflict could hurt the common currency.

In particular, some analysts fear that Vladimir Putin is planning a fresh offensive early in 2023, a year after the invasion began. If this is true, it could put renewed pressure on the single currency.

Additionally, any signs that the conflict may spill over into neighbouring countries could also damage EUR. One worry is that Belarus – a key Russian ally that shares a border with Ukraine – may become directly involved in the fighting. Another is that Russia will try to carve a corridor through Ukraine to reach the breakaway region of Transnistria in Moldova. Either of these developments may dent the euro.

More volatility

Overall, it looks like it could be another tough year for the pound-euro pair. However, considerable uncertainty remains. It’s unclear how long inflation will remain elevated, what will happen in Ukraine, or how central banks will act through the second half of the year. Meanwhile, other factors could increase global uncertainty, such as the impact soaring Covid cases in China could have on world supply chains. As a result, we’ll likely see more volatility throughout the year. Nevertheless, things currently look more favourable for the euro than the pound.

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