EUR/GBP options turn bullish! French fiscal risk may already be overpriced; traders bet on further exchange rate rebound.

After the EUR/GBP exchange rate suffered a historic sharp decline, options traders are positioning for a further rebound in the euro, betting that the euro had already priced in excessive risk surrounding the French situation. As a gauge of market positioning and sentiment, EUR/GBP risk reversals have risen to their most bullish-on-euro level since early October, indicating growing demand for upside exposure to the euro. Currently, EUR/GBP is around 0.8365, about 0.6% above its recent low. Previously, the pair had fallen about 3% from its late-September high. Van Luu, head of global currency and fixed income solutions strategy at Russell Investments, said: "The market has priced excessive pessimism about French risk into the euro." He added that the resilience shown by the UK economy has already been fully reflected in sterling's exchange rate, and that relative to sterling, the euro has deviated from the fair level implied by relative interest rates. Bullish EUR/GBP bets are heating up across tenors Between September 25 and October 30, the decline in EUR/GBP ranked among the top 1% of the largest declines across all 25-trading-day windows over the past five years, and the frequency of daily declines actually set a record. October was also the pair's worst month since July 2022, further fueling expectations that its move may face a technical rebound. Two main factors drove the euro lower. First, concerns over France's fiscal position weighed on European assets, with the market worried that the French government cannot effectively control its growing public finance burden. Meanwhile, resilient UK economic growth, signs of stabilization in the labor market, and easing political risk provided support for sterling. Persistent French fiscal pressure has become an important drag on the euro's recent weak performance. France not only faces a high fiscal deficit and rising government financing costs, but its fragmented political landscape also makes it difficult to implement fiscal consolidation measures. Eurozone finance ministers had previously urged France to pass a credible 2027 budget to restore investor confidence. At the time, the yield on French 10-year government bonds rose to a 25-year high, with concerns over France's fiscal deficit, political divisions, and future large-scale debt issuance continuing to mount. Bank of France Governor Emmanuel Moulin also said on the 4th of this month that France must rely on domestic policies to solve its own fiscal problems and cannot count on the European Central Bank to step in and resolve the crisis. He pointed out that political uncertainty is an important factor pushing up the risk premium on French government bonds, and that passing the 2027 national budget will be the key first step to restoring market confidence and easing pressure on financial markets. Van Luu said that although France's fiscal situation remains severe, Russell Investments' base-case judgment is that the French budget will ultimately pass. In addition, the European Central Bank has multiple policy tools that can limit further intensification of market pressure. However, whether France can smoothly pass the budget and whether the government can truly advance fiscal consolidation will remain important variables affecting the euro's trajectory. EUR/GBP rebounds from its worst monthly performance since 2022 Compared with the fiscal and political pressure facing France, the UK economy has recently shown some resilience. Data from the UK Office for National Statistics showed that the UK economy grew 0.7% in the three months through August 2026, and gross domestic product (GDP) grew 0.1% month-on-month in August. Meanwhile, the UK labor market also showed signs of stabilization: in the three months through August, the unemployment rate fell to 4.7% from 4.9% previously, and payroll employment rose by 13,000 in September. The composite purchasing managers' index (PMI) rose to 52.9 in October, an eight-month high, with activity in both manufacturing and services improving. The UK economy's better-than-expected performance has also partly changed the market's judgment on the Bank of England's monetary policy path. The Bank of England announced on November 5 that it would raise the benchmark rate by 25 basis points to 4%, with the Monetary Policy Committee approving the decision by an 8-1 vote. The Bank of England noted that the UK consumer price index (CPI) rose 3.5% year-on-year in September, and against the backdrop of persistently high energy prices, inflation is expected to rise to about 5% by mid-2027. At the same time, recent economic activity has been stronger than expected and the labor market has shown signs of stabilization, increasing the risk that higher energy prices pass through to broader inflation. The Bank of England's rate hike also highlights the difference in the interest rate environment between sterling and the euro. The European Central Bank had previously raised its deposit facility rate by 25 basis points to 2.5% in September, while the Bank of England's benchmark rate has now risen to 4%. The relatively higher UK interest rate level, as well as market expectations that UK rates may remain high for longer, both provide support for sterling. However, the Bank of England also emphasized that future rate decisions are not on a preset path and will still depend on changes in data such as inflation, wage growth, and economic activity. From the perspective of exchange rate moves, the contrast between French fiscal risk and UK economic resilience has already been fairly fully reflected in EUR/GBP. In its November foreign exchange outlook, MUFG pointed out that sterling has recently benefited from better-than-expected UK economic growth and rising market expectations of tighter UK monetary policy. The institution expects EUR/GBP to be around 0.84 by the end of the fourth quarter of 2026, rise to 0.85 by the end of the first quarter of 2027, and reach 0.86 and 0.87 by the end of the second and third quarters, respectively, indicating a judgment of a gradual recovery in the pair's medium-term trajectory. Van Luu said Russell Investments is tactically buying EUR/GBP and expects the cross to rise 3% to 4% over the next three to six months. He noted that the firm prefers to express its view on a euro rebound through long EUR/GBP rather than long EUR/USD, because the EUR/GBP pair is less affected by geopolitical shocks. It should be noted that the rebound logic for EUR/GBP does not mean that French fiscal risk has disappeared, nor does it mean that the supporting factors for sterling are reversing. Whether the French budget can pass smoothly, whether UK inflation will push rates higher, and future policy divergence between the European Central Bank and the Bank of England may all affect the pair's subsequent trajectory. For the options market, the shift in risk reversals toward a bullish euro reflects more a reassessment by investors of euro downside risk and a bet on the exchange rate recovering from an extreme decline, rather than confirmation of a trend reversal.