(Bloomberg) -- U.K. currency and bond markets are testing levels last breached before the Brexit referendum as the Bank of England looks poised to leave the European Central Bank in the dust by tightening monetary policy again this week.
Sterling is nearing the strongest level against the common currency since Britain voted to leave the European Union in 2016, spurred by the BOE's hawkish stance. Meanwhile, the worst start to the year for gilts since 2018 has widened the spread between 10-year bonds and equivalent German paper to just shy of 130 basis points, a level last crossed before the vote.
How resilient those thresholds prove to be depends largely on whether policy makers at the BOE and ECB live up to expectations when they set policy on Thursday. Momentum is building as traders play up the policy divergence between the two.
Money markets are wagering the BOE will raise borrowing costs by another 25 basis points, taking the bank rate to 0.5%, which could lift the pound further against the euro. The ECB is only expected to start tightening in September, and could push back on bets for rate hikes this year, potentially weighing on German yields.
“The ECB's expected policy path is further set to diverge relative to several other major central banks,” wrote Paul Robson, senior currency strategist at NatWest Markets. “Confirmation that this is still the case at this week's meeting, can push the EUR yet lower.”
He sees the common currency sliding to 80 pence, a level last reached on the day of the Brexit referendum. Having fallen close to 6% over the past year, it was 0.1% higher at 83.43 pence at 11:13 a.m. in London, after euro-area inflation unexpectedly rose to a record 5.1% in January.
For technical analysts, the first major hurdle for the euro-pound cross on the downside is 0.8278-82, which marks the December 2019-February 2020 double-bottom.
A similar dynamic can be observed in the rates market, where the U.K. 10-year yield premium over its German counterpart jumped by the most in almost a year last month. The spread narrowed one basis point to 126 at 11 a.m. following the surprise jump in euro-area inflation.
For the gap to “break above” 130 basis points, the highest level since April 2016, “all we need to have is a rate hike from the BOE and the ECB to remain neutral on inflation,” said Althea Spinozzi, a fixed income strategist at Saxo Bank A/S.
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