06:42 AM EDT, 03/17/2025 (MT Newswires) -- Sterling (GBP) has outperformed alongside other European currencies this month benefitting from the "significant" improvement in investor sentiment towards the region, said MUFG.

It has helped to lift cable back up towards the 1.3000 level for the first time since last year's United States election, wrote the bank in a note to clients. In contrast, sterling has weakened modestly against the euro (EUR) lifting EUR/GBP back above the 0.8400 level for the second time this year.

The euro is expected to benefit more than sterling from Germany's plans for looser fiscal policy, stated MUFG. The last time EUR/GBP rose above 0.8400 in January it was driven more by negative sentiment towards the pound reflecting concerns over UK government debt.

Market participants now expect monetary policies between the European Central Bank and Bank of England to diverge less going forward which has helped to narrow yield spreads in favor of a stronger euro, pointed out MUFG.

At the ECB's last policy meeting, it left the door open for further modest rate cuts with the policy rate now closer to the neutral estimate put forward by President Christine Lagarde between 1.75% and 2.25%.

Based on the bank's assumption that legislation will be passed on Tuesday to boost fiscal policy in Germany, it will ease pressure on the ECB to lower rates below neutral. The main risk to that view would be a much bigger hit to growth in Europe from U.S. President Donald Trump's upcoming plans for trade tariffs in early April.

The European Union's decision to quickly retaliate by imposing tariff hikes from next month on 26 billion euros of U.S. imports in response to U.S. tariff hikes on steel and aluminum imports has angered President Trump, and he has since threatened to impose 200% tariffs on over $10 billion of alcohol imports from the EU.

In contrast, the Trump administration has praised the United Kingdom government for its decision not to retaliate. It will further encourage market expectations that the U.K. economy won't be hit as hard by further tariff hikes in the coming months.

Market expectations for BoE policy have recently been relatively more stable than for the ECB, according to MUFG. The U.K. rate market is still expecting the BoE to stick to the current quarterly pace of rate cuts by delivering the next rate cut in May -- 19bps of cuts priced in -- and then again in August -- 44bps of cuts priced in. However, there is less confidence that rates will fall further below 4.00% by the end of this year.

It's helping to keep yields in the U.K. at higher levels than on offer in other major economies providing support for the GBP, added the bank. The BoE holds its latest policy meeting on Thursday. Ahead of that meeting, U.K. economic data has been improving except for Friday's softer UK gross domestic product report for January.

Overall it points to strengthening growth momentum since late year. At the same time, the slowdown in services inflation and wage growth remains frustratingly slow.

It will become more uncomfortable for the BoE to keep cutting rates heading into the summer when inflation is expected to temporarily pick up towards 4.0%.

Overall, sterling remains "attractive," noted MUFG. A deeper sell-off for global equity markets that undermines financial stability poses the main downside risk for sterling.