ECB Dovish Tilt Favourable to Sterling Amid Rate Hike Expectations

ECB President Christine Lagarde's comments on Monday have provided sterling with its clearest route higher against the euro. The pound-to-euro exchange rate has held near 1.1664, extending gains from oil-driven market movements on Monday.

Lagarde told the European Parliament's economic committee that the energy shock has yet to feed through to wages, and that 'we view a measured response as appropriate to keep inflation in check.' This suggests that the ECB may not be inclined to hike interest rates in October, contrary to previous market expectations. Francesco Pesole, FX Strategist at ING, notes that Lagarde's comments have toned down some of the market enthusiasm for an October hike.

The gap between US and Eurozone rate expectations has widened further, with markets pricing in 17bp of Fed tightening in October and just 9bp from the ECB. This divergence in interest rates is favourable to sterling, particularly since the Bank of England is likely to hike its base rate on November 5.

The pound-to-euro exchange rate faces resistance at 1.1689, but a break above this level requires the ECB to extend its dovish stance. Meanwhile, Lagarde's comments have lifted some support off the euro, which trades near 1.1348 against the dollar.