By mid 2025 the euro had depreciated against the pound to a two-year low of £0.81 as speculators bet that the European Central Bank would loosen policy more quickly than the Bank of England. It was a turn of events from 2023 when worries about soaring inflation had sent the euro upwards against the pound.
The reasons lay in divergent economic outlooks with the slowdown in the eurozone economy contrasting with the resilience of the British economy in terms of wages and consumer spending.
Diverging Monetary Policies
ECB President Christine Lagarde has signalled that inflation is "decisively converging" and that rates could come down as soon as September 2025. At the same time, Bank of England Governor Andrew Bailey has warned that British monetary policy will remain tight until services inflation comes down.
According to money market futures there are two ECB rate cuts expected by year-end against none for the BoE, the biggest differential in a decade.
Economic Indicators
The latest growth figures show why investors are turning away from the euro and into the pound. While the eurozone's growth slowed to a mere 0.3% on a quarterly basis, with Germany even shrinking slightly due to weak manufacturing exports, the British economy grew by 0.5% on the back of a resilient retail sector and tourism following a hot summer.
It shows in the investments with funds flowing into the London stock market and out of bond funds on the Continent.
Real-World Repercussions
While a weaker euro helps some businesses in the export-reliant south of Europe, it makes it harder to control inflation if energy prices rise. At the same time, a stronger pound hits British exporters but also lowers their cost of imports and increases disposable income.