The EUR/GBP exchange rate has dropped below 0.8750, now trading around 0.8725 for the fifth day in a row. This decline follows the Bank of England (BoE) lowering its benchmark interest rate by 0.25% to 3.75%, marking the first cut since August. Despite this adjustment, the BoE indicates that further rate cuts will be limited due to ongoing inflation worries. Money markets expect the BoE to implement at least one more rate cut in the first half of the year, with nearly a 50% chance of an additional cut by the end of the year. Looking ahead, the market sees a gradual easing path from the BoE by 2026, which may support the Pound against the Euro in the short term.

European Central Bank Decision

The European Central Bank (ECB) decided to keep its key interest rates steady at its recent meeting. This is the fourth consecutive meeting with unchanged rates, as ECB President Christine Lagarde emphasized the importance of remaining flexible. Currently, the chance of a rate cut by the ECB in February 2026 is low, below 10%. If the ECB stabilizes its rate cycle, it could help slow the Euro’s depreciation. As the Bank of England signals that it will proceed slowly with further rate cuts, the Pound Sterling may continue to outperform the Euro. The EUR/GBP exchange rate has dropped below 0.8750, and this downward trend is likely to continue into the new year. The difference in policies between a cautiously easing BoE and a steady ECB primarily drives this trend. Recent data backs up this view. The UK’s Office for National Statistics reported that inflation in November 2025 was 2.9%, significantly above the BoE’s target of 2%. This supports Governor Bailey’s cautious approach, making the market’s expectation of only one or two gradual cuts in 2026 seem reasonable, boosting the Pound. On the flip side, the Eurozone’s flash Harmonised Index of Consumer Prices for December 2025 stood at 2.5%, also above the target. While this justifies the ECB’s choice to maintain rates, the Eurozone’s weak economic performance—Q3 2025 GDP at only 0.1%—presents risks. The market assigns less than a 10% chance of an ECB rate cut by February 2026, a figure that may change if economic activity slows.

Implications for Derivatives Traders

For derivatives traders, the current environment favors strategies that benefit from a continued decline or stable pricing in EUR/GBP. With the exchange rate below 0.8750, selling out-of-the-money call options with strike prices at 0.8800 or higher for January and February 2026 could be a smart move to earn premiums. The low one-month implied volatility, recently around 5.2%, makes these strategies appealing. However, traders should be cautious as longer-term volatility is increasing, with six-month implied volatility nearing 6.5%. This indicates uncertainty about the central banks’ actions later in 2026. Thus, traders might consider buying inexpensive, longer-dated put options to guard against a larger drop in the pair, especially if UK economic data continues to outperform that of the Eurozone. We have previously observed such policy divergence resulting in sustained trends, as seen during the 2022-2023 interest rate hikes when central banks acted at different paces. In those times, the relative strength of one currency over another continued for several quarters. This history suggests that the current weakness in EUR/GBP may not be temporary but could shape trading strategies for the first quarter of 2026. Create your live VT Markets account and start trading now.

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