Sterling has remained relatively steady against the euro this week, with investors balancing two competing forces, the UK’s higher inflation rate and improving activity indicators, against a growing debate over when the Bank of England may begin cutting interest rates.
The euro has been supported by lower inflation readings across the single-currency bloc, which have reduced pressure on the European Central Bank to tighten policy further. At the same time, business surveys suggest the eurozone is still expanding, although at a slower pace than the UK.
Central banks set the near-term tone
Currency markets continue to react most strongly to expectations for interest rates.
In the UK, the Bank of England has held rates at 3.75%, but the most recent decision was closely split, signalling that some policymakers are increasingly open to a cut if inflation continues to cool. For the pound, the key question is whether the Bank sees enough evidence of easing price pressures to begin lowering borrowing costs in the spring.
In the euro area, the ECB has also kept rates unchanged, with the deposit rate at 2.00%. With inflation now below 2% on the latest flash estimate, investors are assessing whether the ECB will stay on hold for longer, or whether cuts may become more likely later in 2026 if growth remains modest.
Inflation trends remain an important differentiator
Inflation in the UK is running higher than in the euro area. UK CPI eased to 3.0% in January, but remains well above the latest euro area inflation estimate of 1.7%.
For investors, this gap matters because it shapes expectations for where interest rates may settle. If UK inflation proves more persistent, it can reduce the scope for rapid rate cuts and provide some support for sterling. If inflation falls quickly towards target, it can have the opposite effect, particularly if markets begin pricing a faster UK easing cycle than in the euro area.
Business surveys point to firmer UK momentum
Survey data has shown UK private sector activity continuing to expand into February, with the composite PMI at its highest since April 2024. The eurozone composite PMI also indicates expansion, but at a lower level.
While PMI data is not the same as official output figures, it is closely watched because it provides a timely read on demand, hiring intentions, and price-setting behaviour. Stronger relative momentum tends to support a currency, especially if it influences how central banks view the growth outlook.
Energy prices and market sentiment are mixed inputs
Energy markets have been active, with Brent crude trading near seven-month highs amid geopolitical tensions. Higher oil prices can feed into inflation expectations, which in turn can influence the path of rates.
European gas prices have eased in recent sessions, which can help reduce cost pressure in parts of the euro area. The combination of firmer oil and softer gas leaves a mixed picture for currency markets.
Broader market sentiment has also been relatively balanced. Measures of equity volatility are not showing a clear risk-on signal, which matters because sterling can be more sensitive to shifts in investor appetite for risk than the euro.
What investors are watching next
For the coming sessions, attention is likely to remain on:
- Bank of England communication ahead of the next policy meeting, including how policymakers frame services inflation and wage pressure
- Eurozone inflation updates and business sentiment indicators, particularly in the larger economies
- Any shift in rate expectations implied by bond market moves, as yield differentials remain a key driver of GBP/EUR
GBP/EUR remains driven by the interaction between relative inflation, growth momentum and interest rate expectations. UK data has offered some support for sterling, but the prospect of near-term easing by the Bank of England is a constraint, leaving investors focused on whether upcoming releases confirm a gentle disinflation path or point to renewed persistence in domestic price pressure.
