Sterling has fallen by 7.5% against the euro since mid-May. The fall comes despite relative interest rate expectations pointing to a strengthening of the pound against the single currency. But while conventional monetary policy looks likely to be tightened in the UK well before the euro-zone, the currency bloc’s recent growth spurt has led to increasing anticipation that the ECB will wind down its asset purchases next year. Weakness against the euro is by no means limited to the pound alone. The US dollar has fallen against the single currency to a similar extent. However, if domestically-generated inflation in the UK and US increases as we expect, investors’ focus will return to conventional monetary tightening which would stem the euro’s gains. Accordingly, rather than fall further as some expect, we think that some of the recent weakness of sterling against the euro will be reversed, leaving the exchange rate at €1.13 at year-end, slightly above its current level of €1.10.
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