The GBP EUR exchange rate recovered some ground towards the weekend after the final Q2 GDP reading showed a better-than-expected performance for Q2. This helped the pound which has been struggling with the surge in wholesale gas prices and another three firms went bust. In Europe, Germany saw a slight improvement in unemployment, but inflation rose to a thirty-year high.
The GBP to EUR was trading above the 1.1650 level once more ahead of a quiet week for data.
Worries of stagflation in the UK as inflationary problems mount
The recent fuel shortages and surge in gas prices are giving rise to fears of stagflation in the UK- a period of stagnating economic growth, alongside higher inflation.
Many analysts have suggested that the BoE may be making a policy error by not responding to these pressures with enough haste.
Oliver Blackbourn, multi-asset portfolio manager at Janus Henderson investors, said the need to act is greater as pandemic support is removed.
“If the current spike does not abate, the BoE may need to increase interest rates faster than it would want to as it tries to prevent higher inflation becoming endemic,” he said.
“Rapidly increasing interest rates could stall the economic recovery and risk plunging the UK into a recession. Higher interest rates would be bad news for UK Government bonds but could support the pound in the short term if markets have greater confidence in the Bank’s ability to calm inflation without risking slowing the economy.
However, if markets sense that the economy is at risk, sterling may weaken as investors switch to currencies with better underlying economics.”
Thursday saw the end of the furlough scheme in the UK after 18 months.
Europe not immune to the sterling shocks
There’s a growing sense that the pound sterling is living in an isolated bubble when it comes to gas prices and dynamics such as stagflation.
But yesterday saw Germany’s inflation rate at a thirty-year high so it is obvious that the situation is the same. Traders are hanging on data releases to see if they can confirm a German recovery, but the economy will likely see the same fate as the UK, which has seen a post-reopening bounce start to normalise.
The British economy actually has a benefit in that the central bank has only one, or arguably four, nations to deal with. The European Central Bank has to consider many more and they cannot be comfortable with the German inflation numbers.
Other European nations are struggling with higher inflation also as the ECB’s 2% target is being squeezed by France, Italy and Spain.
European natural gas prices have also jumped to record highs as traders watch for any sign of extra fuel from the region’s biggest supplier Russia. Asian spot prices are also surging as Buyers from China to South Korea are having to compete with Europeans for any available cargoes.
The situation could make for a winter crunch in the UK or Europe this year and could continue to affect the pound.