EUR/GBP has been driven by short-term rate differentials for the majority of the recent past. Economists at Société Générale analyze GBP outlook.

Supported by rates, vulnerable when they peak and as growth slows

Random recurrent crises notwithstanding, Sterling is being supported by a faster pace of rate hikes than elsewhere, and markets are now pricing a higher peak in the UK than in the eurozone or US. That will support GBP for as long as this unusually close correlation between currencies and short-term rates persists and until the rate outlook changes. 

The UK has a less attractive growth/inflation trade-off than other major economies, something which has been exacerbated by Brexit. The upshot of that will be weaker growth and higher inflation over 2023-2024 than in the Eurozone. 

Sterling can only expect support from higher rates for so long before the growth outlook (and the longer-term interest rate implications of weak growth) takes over. We think that will start to happen in 2H23 as rates approach their peak.