EUR/GBP Bull Flag Strengthens as Inflation Divergence Widens
The EUR/GBP currency pair has been trading within a short-term bull flag, and recent inflation data suggests that it may continue to rise. According to the data, the UK's inflation rate rose from 2.6% to 2.9% in July, but this increase is largely due to an external energy shock rather than a domestic reacceleration.
On the other hand, euro-area inflation also increased to 2.9%, but with slightly firmer persistence, particularly in services inflation and core inflation. This divergence in inflation rates gives the Bank of England more room to look through the move if it believes that the pressure is not spreading meaningfully through the wider economy.
The bond market is starting to confirm this story, as the German 2-year minus UK 2-year yield spread has been trending higher. Although still negative, the direction matters most, and a narrowing of the spread indicates that markets are beginning to lean slightly more towards the euro on a relative policy basis.