FXStreet (Delhi) – Jane Foley, Research Analyst at Rabobank, notes that since the start of the month EUR/GBP has recovered around 3.3% and the move is likely to have been greeted with some relief to BoE policy setters who have been viewing sterling strength as a headwind to UK economic activity. Key Quotes “The minutes of the November MPC meeting warn that “subdued overseas demand and the rise in the sterling exchange rate since mid-2013 were likely to have weighed on growth in both the manufacturing and services sector”. Measured since March 2013, the UK effective exchange rate has risen by almost 19%, though it remains well below it pre-crisis levels.” “In our view, the outlook for BoE interest rate policy is irreversibly tied to the performance of the exchange rate. While the outlook for GBP/USD is important, due to the more substantial trade flows with the Eurozone, the EUR/GBP exchange rate would appear to have greater weight. For this reason the failure of the EUR to soften on the back of the ECB’s policy meeting last week was probably greeted with a sigh of relief by UK policy setters.” “A broadly weaker EUR would likely have corresponded with additional strength in sterling and implied another tightening in UK monetary conditions. That said, even though it may be inferred from this logic that a higher value in EUR/GBP may mean an earlier increase in BoE interest rates, we would argue that the factors that will drive the first hike in policy are yet to come into sharp focus.” “Currently it seems likely that McCafferty will remain the lone hawk at this week policy meeting, with weaker data from the UK manufacturing sector, sterling strength and concerns over emerging market growth all posing as headwinds to a potential BoE interest rate hike. That said, over the coming months base effects suggest that CPI inflation will begin to tick higher and this will ensure that sterling markets remain focused on the timing of the first BoE rate move.” “On balance we do not expect the BoE to announce its first 25 bps rate hike of the cycle before August 2016. Although the Bank may not be in any rush to tighten, its first move is still likely to correspond to very easy policy settings at the ECB. Consequently we continue to expect EUR/GBP to continue to grind lower towards 0.68 on a 12 mth view.” For more information, read our latest forex news.