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Pound reaches 20-month high against euro as interest rate bets diverge

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In this photo illustration, British Pound and Euro currency bank notes seen displayed. (Photo by Dinendra Haria / SOPA Images/Sipa USA)
For the month-to-date, the pound is outperforming the euro by about 2%, on track for its second biggest monthly gain in two years. Photo: Dinendra Haria / SOPA Images/Sipa USA

Sterling hit a new 2021 high against the euro (GBPEUR=X) on Tuesday morning in London to trade at its highest level since pandemic-induced market turmoil in March 2020.

Investors are currently pricing in a Bank of England interest rate hike at its next meeting on 4 November. 

For the month-to-date, the pound is outperforming the euro by about 2%, on track for its second biggest monthly gain in two years.

On Tuesday, sterling gained 0.2% to trade at €1.1874.

Expectations about an interest rate hike in the EU are less optimistic, however, with signs showing the ECB could be among the last to raise rates in the developed world. 

Meanwhile, UK bond yields continued to surge with the 10-year yield above 29-month highs, boosting GBP demand, particularly against low-yielding currencies like EUR.

The pound has been mostly gaining steadily against the euro since December 2020. Chart: Yahoo Finance UK
The pound has been mostly gaining steadily against the euro since December 2020. Chart: Yahoo Finance UK

"Growing monetary policy divergence between the Bank of England (BoE) and European Central Bank (ECB) has given the pound a substantial yield advantage versus the euro, allowing the currency pair to extend higher," said George Vessey, of Western Union Business Solutions.

"Investors will be looking for confirmation of this narrative when the ECB meet this Thursday, expected to remain ultra-accommodative, compared to the BoE meeting next Thursday where rate hikes are on the agenda."

Read more: Budget 2021 preview: What to expect from chancellor Rishi Sunak's spending review

In addition to monetary policy, sterling sentiment may be impacted by any major fiscal policy changes announced by chancellor Rishi Sunak at his UK budget and spending review on Wednesday.

European dovishness is also being spurred on by data released on Monday, which showed German business morale deteriorated for a fourth month in a row in October. 

Watch: Treasury tells Michael Gove not to expect lots of new cash for levelling up

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